Hi Sharks - Identifying Implicit Costs and Economic Profit on Shark Tank

This activity is appropriate for a principles course. It can be completed near the beginning of a principles course as the concepts are basic. It should be completed right after or right before discussion of implicit vs explicit costs. Students need to know the definition of profit (revenues minus costs). They also need to know that implicit costs must be counted along with explicit costs to determine if an economic profit (and not just an accounting profit) is being generated. As such, they need to know the difference between economic profit and accounting profit.

There is no class size restriction and the activity should be able to be completed fairly quickly – perhaps half a class period.

Overview

Students are given a scenario where a small business is seeking investment on the show Shark Tank. They are then given data on a small business's revenue and expenses. Conspicuously absent from the expenses are wages and rent. Students should deduce that while the business looks profitable on paper, the implicit costs of the small businessperson's labor and use of their property actually shows the business is not profitable. Different sharks have different opinions on the situation which students are asked to evaluate.

Expected Student Learning Outcomes

After completing this activity, students should be able to distinguish between explicit and implicit costs. They should also be able to identify implicit costs and incorporate them into assessing profitability.

Information Given to Students

Hi Sharks, today I am here to tell you about my patented Gizmo gadget company. I have been in business for 1 year and have already generated $100,000 in sales. As you can see, my profit margin was 44% which is quite high. I left my $50,000 a year job to start this business in my garage. The business is my focus full-time so I am determined to grow this company and make it work. Who wants to invest?

Gizmos Inc Financial Data (Full Year):

Revenue $100,000

Casings $25,000
Wires $15,000
Buttons $10,000
Loan Payment $6,000

Net $44,000

After reviewing the numbers, the sharks respond. Using what you have learned in class, which shark do you agree with?

A.) Kevin: "These numbers are very strong. I could use a highly profitable gadget company in my portfolio. I'll offer you a deal."

B.) Daymond: "I don't know what Kevin is talking about here. This company is losing money and there's no way I will invest. I'm out"

C.) Barbara: "Daymond is right, this business is losing money. But I think there is enough going for it that I see an opportunity. I'll offer you a deal."

Shark Tank is a reality show on ABC which began in 2009 in the wake of the Great Recession. Judges are a group of "Sharks" who are successful real-life entrepreneurs. Contestants are small business owners who pitch to the sharks in hopes of getting an investment. Oftentimes when the contestants give their sales figures to the sharks, the sharks ask "do you pay yourself." This is to ascertain whether the company's stated profit rate includes an explicit cost of wages to the owner, or whether there is an omitted implicit cost which can change the sharks' opinion of the viability of the company.

Students should need minimal direction to get started. Taking implicit costs into account, groups are likely to spend their time deciding between choices B and C.

Explanation of Choices

A.) Kevin says it is profitable and will invest - This choice is the least defensible of the three. On paper the company looks quite profitable and has a large margin. We can tell from the blurb, however, that the entrepreneur is not considering large implicit costs. They are forgoing their $50,000 salary they could have earned. This is an opportunity cost that should be factored in. Taking this into account, they actually made a $6,000 economic loss. They are also using their garage which they could have used for other purposes. Students can still defend this answer by saying the firm is making an accounting profit, but the goal is to get them to consider economic profit as well.

B.) Daymond says it isn't profitable and won't invest - We can see from this that Daymond is taking into account implicit costs. While the firm is making an accounting profit, it is making an economic loss. Daymond has a strong argument for not investing in the company.

C.) Barbara says it isn't profitable but will invest - When studying economic profit and loss we can fall into the habit of just assessing it on a static basis. A fundamental aspect of business is risk, uncertainty, and the possibility of future growth. Barbara sees that this business has grown to 6 figures in its first year of operation. Students might argue the business could be on a growth trajectory which will soon make it profitable, even taking into account implicit costs. This choice highlights that there are more elements of complexity when evaluating real world situations than textbooks sometimes allow.

Potential Issues

The instructor should make sure there is vibrant discussion happening in each group. While the activity is likely to be quick, students should be encouraged to think critically about all the answers.

Summary / After the Activity

After the activity, the instructor can lead a discussion regarding the role of explicit and implicit costs in starting a small business. The instructor can let students know there are different philosophies on the subjects, even among the Sharks. Below are articles where Sharks espouse contradictory views on the subject:

https://www.cnbc.com/2017/06/08/daymond-john-says-never-quit-your-day-job.html

https://www.yahoo.com/news/shark-tank-star-kevin-o-000000433.html

https://www.cnbc.com/2018/10/15/shark-tank-judges-kevin-oleary-and-robert-herjavec-debate-when-to-quit-your-job.html

Instructors will be able to assess students' understanding based on their ability to defend their answers between B and C. A potential essay could for students to perform thought experiments about what implicit costs they may incur if they started their own small business.