Airbnb Entrepreneurs

Richard Gosselin, Houston Community College,

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Summary

Students groups examine the situation in which an Airbnb entrepreneur has taken out five separate mortgages in a lake resort community. Each mortgage also has maintenance and electrical bills. A recession depressed rental rates substantially, and it is the task of each entrepreneur to determine the lowest rental rate they can accept on the Airbnb platform before deciding whether it is better to simply not rent them out at all.


Context for Use

Often students have a hard time distinguishing between operating profit and economic profit as well as knowing the difference between the short run and the long run. Knowing when and how to minimize losses is just as important is knowing how to maximize profits. This group exercise provides the context for applying these important economic principles in a real-world scenario.

Overview

The example in this group activity relates to an Airbnb entrepreneur who owns a handful of cottages in a lake resort community and is trying to determine what rent is the lowest she can accept in the face of a sluggish rental market brought on by a recession.

Expected Student Learning Outcomes

Students will be able to identify the price point when shutting down is the most rational decision to make in the short run. They will also be able to distinguish between economic profit and operating profit and apply these concepts in context to a real-world scenario.

Information Given to Students

You are an Airbnb entrepreneur owning several cottages in a lake resort community. You took out mortgages on five of them and have successfully rented them out. To date, you have been able to enjoy a handsome economic profit. The monthly mortgage payments come to $1800 per cottage. In addition, the utilities and the maintenance are roughly $350 per unit and zero when they are not being rented out on Airbnb. Assume that there is a severe recession and the rents in this local resort community have been falling sharply. Examine the following and determine which is the best course of action. More than one answer might be correct.

a. In the short run, you shouldn't accept anything below $2150 per month per cottage. Otherwise, you will be making losses, and it would be better if you didn't rent them out at all.
b. In the short run, you must at least get $1800 per cottage to make the mortgage payments on the cottages.
c. In the short run, you shouldn't accept anything less than the $350 per cottage even though you will be faced with substantial economic losses.
d. In the long run, you would need to receive at least $2150 per cottage.





Teaching Notes and Tips

Debrief

There should be a lively discussion on each of these options because they all appear to have an aura of plausibility. However, only "c" and "d" are correct. Some student groups will be reluctant to choose "c" only because of the emotional effect of the economic losses. Remind them that what matters most in the short run is for her to make an operating profit. Choice "d" is correct because any business must earn normal profit in the long run. Choice "b" looks appealing, after all, she does need to pay her mortgage. But remember, this is a fixed cost. She has to pay it regardless if she finds renters or not. So it's irrelevant in the short run. Choice "a" is incorrect because it starts by talking about the short run. Remind students that this answer would be right on the money if we considered the long run.

Assessment

Assessing the student learning outcomes of this activity can be accomplished in several ways, but a highly effective one is having students frame the issues covered by posting two potential short answer questions on your learning management system that they will be required to respond to.

In your learning management system, consider having students create an original post to the following prompts.

1. A new competitor to Tesla is building an electric car factory and, due to some unforeseen cost overruns, has already spent $4 billion to construct. Assume that it will require another $2 billion to complete; otherwise, it will be useless for any commercial use. However, if it is completed, the future revenues will have a present discounted value of $3 billion for the company. Explain whether the factory should be completed or abandoned.

2. A sports star has just signed a multi-million dollar contract with a professional football team and just purchased an 84-inch flat-screen TV that cost $10,000. Unfortunately, one day the television is no longer able to provide picture quality to make it viewable. He gets a quote from a TV technician to affect repairs and discovers it will cost $3,500 to fix it. He tells the technician that he will need to sleep on it and will get back to him soon. Shortly after, he discovers that a local electronics store is having a going-out-of-business sale and notices that there is a TV with the exact specifications as his in both quality and performance selling for $3,000. Explain whether he should have his TV fixed or buy the new one on sale.

References and Resources

The video below is a short clip that could be distributed to students beforehand in preparation for the activity or afterward, which deals with the concept of the fallacy of sunk costs and why we pay too much attention to them. The video was produced by Intermittent Diversion.

https://youtu.be/AFPgxIJHxsE