Page 575 - Krugmans Economics for AP Text Book_Neat

fyi

Farming in the Shadow of Suburbia
Beyond the sprawling suburbs, most of New Maintaining the land as a farm instead of selling
England is covered by dense forest. But this is it to a developer constitutes a large implicit cost
not the forest primeval: if you hike through the of capital. A fact provided by the U.S. Depart-
woods, you encounter many stone walls, relics ment of Agriculture (USDA) helps us put a dollar
of the region’s agricultural past when stone Michael S. Lewis/National Geographic/Getty Images figure on the portion of the implicit cost of capi-
walls enclosed fields and pastures. In 1880, tal due to development pressure for some
more than half of New England’s land was Rhode Island farms. In 2004, a USDA program
farmed; by 2009, the amount was down to designed to prevent development of Rhode Is-
10%. land farmland by paying owners for the “devel-
The remaining farms of New England are opment rights” to their land paid an average of
mainly located close to large metropolitan In 2009, the average value of an acre of $4,949 per acre for those rights alone. By 2009,
areas. There farmers get high prices for their farmland in the United States as a whole was the amount had risen to $15,357.
produce from city dwellers who are willing to $2,100; in Rhode Island, the most densely pop- About two-thirds of New England’s farms re-
pay a premium for locally grown, extremely ulated of the New England states, the average maining in business earn very little money. They
fresh fruits and vegetables. was $15,300. The Federal Reserve Bank of are maintained as “rural residences” by people
But now even these farms are under eco- Boston has noted that “high land prices put in- with other sources of income—not so much be-
nomic pressure caused by a rise in the implicit tense pressure on the region’s farms to gener- cause they are commercially viable, but more
cost of farming close to a metropolitan area. As ate incomes that are substantial enough to out of a personal commitment and the satisfac-
metropolitan areas have expanded during the justify keeping the land in agriculture.” The im- tion these people derive from farm life. Although
last two decades, farmers increasingly ask portant point is that the pressure is intense even many businesses have important implicit costs,
themselves whether they could do better by if the farmer owns the land because the land is they can also have important benefits to their
selling their land to property developers. a form of capital used to run the business. owners that go beyond the revenue earned.

although the business makes an accounting profit of $35,000, its economic profit is
actually negative. This means that Babette would be better off financially if she closed
the restaurant and devoted her time and capital to something else. If, however, some
of Babette’s cost should fall sufficiently, she could earn a positive economic profit. In
that case, she would be better off financially if she continued to operate the restau-
rant. For instance, consider the column titled Case 2: here we assume that what Ba-
bette could earn as a chef employed by someone else has dropped to $30,000 (say, due
to a soft labor market). In this case, her economic profit is positive: she is earning
more than her explicit and implicit costs and she should keep her restaurant open.
In real life, discrepancies between accounting profit and economic profit are ex-
tremely common. As the FYI above explains, this is a message that has found a recep-
tive audience among real-world businesses.

Normal Profit
In the example above, when Babette is earning an economic profit, her total revenue
is higher than the sum of her implicit and explicit costs. This means that operating
her restaurant makes Babette better off financially than she would be using her re-
sources in any other activity. When Babette earns a negative economic profit (which
can also be described as a loss), it means that Babette would be better off financially
if she devoted her resources to her next best alternative. As this example illustrates,
economic profits signal the best use of resources. A positive economic profit indi-
cates that the current use is the best use of resources. A negative economic profit in-
dicates that there is a better alternative use for resources.

module 52 Defining Profit 533