Suppose you own and operate a coffee shop in your hometown. Each year, you recei

Question

Suppose you own and operate a coffee shop in your hometown. Each year, you receive revenue of $200,000 from coffee sales, and it costs you $100,000 to obtain your raw materials. In addition, you pay $20,000 for electricity, taxes, and other expenses per year. Instead of running the coffee shop, you could become an accountant and receive a yearly salary of $40,000. A clothing retailer, interested in expanding, has also offered to rent your shop space from you for $50,000 per year. How do you explain to your friends that despite making a profit, it is too costly for you to continue running your shop?

Explanation / Answer

Taking about profit, we have two different kinds of cost structures amounting to two different types of profits.

One is accounting profit which accrues from explicit costs and the other is economic profits which accrues from implicit and explicit costs.

Explicit costs imply the out of pocket costs to run a business. However, implicit costs include the opportunity cost foregone when put to usea particular resource. For example, the opportunity cost of running a coffee shop on that particular place is the rent foregone which would have earned otherwise if rented.

Thus explicit costs are =$100,000 + 20,000.

Explicit costs = $120,000.

Revenue = $200,000.

Profits = revenue - cost

Profits = 200,000 - 120,000 = $ 80,000.

This is the accounting profit.

Implicit costs = 40,000 + 50,000

Cost = $90,000.

Implicit + explicit cost = 120,000 + 90,000

Cost = 210,000.

Profits = 200,000 - 210,000 = -$10,000.

Thus it can be clearly seen that operatinga coffee shop is actually incurring economic loss despite having accounting profit.

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