WEBVTT NOTE Mid-Term Review and The Theory of the Firm 1 00:00:00.000 --> 00:00:14.000 Midterm is on Thursday, so today we're going to give a wrap-up of the course so far and then answer questions or whatever you've gotten. 2 00:00:14.000 --> 00:00:26.200 Okay, we've done the first two parts of the course on demand and supply and price and 3 00:00:26.200 --> 00:00:33.360 applications and key studies of government intervention into the PICE system. 4 00:00:33.360 --> 00:00:43.320 We started with the law of diminishing marginal utility, in other words, given this is utility 5 00:00:43.320 --> 00:00:51.340 on the y-axis, and this is quantity, the greater the supply of the good, the lower the utility 6 00:00:51.340 --> 00:00:52.340 of each unit. 7 00:00:52.340 --> 00:01:04.680 That's the lower dimension of marginal utility. 8 00:01:04.680 --> 00:01:13.440 So that if you, this solves the value paradox, in other words, the idea how come that, how 9 00:01:13.440 --> 00:01:17.480 come that water, even though it's extremely important for life, or bread, which is important 10 00:01:17.480 --> 00:01:18.480 for life, is very cheap. 11 00:01:18.480 --> 00:01:22.000 On the other hand, diamonds, which are a mere luxury and frippery, are very expensive. 12 00:01:22.000 --> 00:01:27.600 That's the famous value paradox, solved by concentrating on the unit. 13 00:01:27.600 --> 00:01:32.880 In other words, that the people do not evaluate the entire supply of bread or water or diamonds 14 00:01:32.880 --> 00:01:37.520 for all time or even for the current time, they evaluate each unit, each loaf of bread, 15 00:01:37.520 --> 00:01:45.520 each carat of diamonds, each glass of water or gallon or whatever, and this solves the 16 00:01:45.520 --> 00:01:48.920 value of paradox because there's a lot more bread and water around than there are diamonds 17 00:01:48.920 --> 00:01:58.920 and so the relative scarcity of diamonds is greater, unit, in other words, lower marginal 18 00:01:58.920 --> 00:02:09.240 and Utility. Margin concentrates or focuses on each unit, and utility means value placed 19 00:02:09.240 --> 00:02:19.560 on a unit. So this means, as I say, the greater the supply, the lower the value of each unit. 20 00:02:19.560 --> 00:02:22.280 We don't know the exact slope of this. As a matter of fact, you can't even talk about 21 00:02:22.280 --> 00:02:27.580 the slope, since this value is an ordinal concept, utility is an ordinal concept. But 22 00:02:27.580 --> 00:02:32.060 We do know that it's lower as you get more units of a good. 23 00:02:32.060 --> 00:02:35.220 Taking that and also taking into account every individual in the market has different value 24 00:02:35.220 --> 00:02:42.540 scales and different valuations that he or she places on different commodities, you wind 25 00:02:42.540 --> 00:02:44.380 up with a falling demand curve. 26 00:02:44.380 --> 00:02:53.380 In other words, the price of any good or service on the y-axis, quantity on the x-axis and 27 00:02:53.380 --> 00:02:58.260 Any given price, at a higher price, people will buy less of it, at a lower price they'll 28 00:02:58.260 --> 00:03:03.260 buy more of it, you get something like that. 29 00:03:03.260 --> 00:03:07.260 We don't know that it's linear, we just know that it's falling, in that sense it's a little 30 00:03:07.260 --> 00:03:11.740 bit like a utility curve there. 31 00:03:11.740 --> 00:03:17.100 Just for convenience we make it a straight line, but all we know is people will buy more 32 00:03:17.100 --> 00:03:21.140 of it at a lower price and less of it at a higher price, that's the key, and by knowing 33 00:03:21.140 --> 00:03:23.660 Considering that, you already know more than most of the people in the United States, because 34 00:03:23.660 --> 00:03:28.020 most people think that the man curve, think of it as vertical, and regardless of what 35 00:03:28.020 --> 00:03:30.820 the price is, people buy the same amount. 36 00:03:30.820 --> 00:03:35.780 You know, they and their daily lives, of course, don't act that way. 37 00:03:35.780 --> 00:03:45.780 So we have a falling demand curve, and the major property of the demand curve is elasticity. 38 00:03:45.780 --> 00:03:57.780 This is an analogy for physics or physical sciences where if you place a certain amount of weight on a spring, it's more elastic the more distance it moves by putting a weight on it. 39 00:03:57.780 --> 00:04:07.780 Less elastic, less distance it moves. Similarly, the elasticity is how much if a price falls, the price of any good falls, how much will quantity increase? 40 00:04:07.780 --> 00:04:14.780 If it only increases a little bit, the man curve is sort of inelastic. If it increases a lot, it's sort of elastic. 41 00:04:14.780 --> 00:04:25.780 So in a sense, the flatter, given the given point, I can hear the flatter the curve, the more elastic it is, and the steeper, the less elastic. 42 00:04:25.780 --> 00:04:34.780 The man curve cannot be horizontal because it's falling at any given price, and it can't be vertical for the same reason. 43 00:04:34.780 --> 00:04:39.780 Any demand curve will be within this structure. 44 00:04:39.780 --> 00:04:44.780 You can define elasticity in various ways. 45 00:04:44.780 --> 00:04:49.780 The textbook definition is alright for its own purposes. 46 00:04:49.780 --> 00:04:54.780 Elasticity is the percentage change in quantity divided by percentage change in price. 47 00:04:54.780 --> 00:04:59.780 That's one way to do it. The trouble with that is, there's nothing wrong with it mathematically, 48 00:04:59.780 --> 00:05:01.460 It's irrelevant economically. 49 00:05:01.460 --> 00:05:05.020 Nobody really measures this thing because nobody knows what it is anyway. 50 00:05:05.020 --> 00:05:08.460 And from an economic point of view, from the point of view of the business man, the firm 51 00:05:08.460 --> 00:05:11.140 or the industry, what's really important is the direction. 52 00:05:11.140 --> 00:05:12.140 What happens to total revenue? 53 00:05:12.140 --> 00:05:13.500 That's what it's really concerned with. 54 00:05:13.500 --> 00:05:16.380 If you cut price, will total revenue go up or go down? 55 00:05:16.380 --> 00:05:23.060 It could work either way, since total revenue is equal to price times quantity, as the price 56 00:05:23.060 --> 00:05:25.780 falls, these two things are going in opposite directions. 57 00:05:25.780 --> 00:05:29.600 In other words, as the price goes down, quantity goes up. 58 00:05:29.600 --> 00:05:34.440 And what the impact on total revenue is purely depends on the problem, depends on the good 59 00:05:34.440 --> 00:05:36.760 and the people buying it and all that sort of stuff. 60 00:05:36.760 --> 00:05:42.880 Nobody knows in advance what it is, they can have hunches, but nobody knows any precision 61 00:05:42.880 --> 00:05:46.440 what the elasticity of the man curve is at any time. 62 00:05:46.440 --> 00:05:55.680 So the way I define elasticity is the man curve is elastic if when price change, when 63 00:05:55.680 --> 00:05:58.680 When price falls, total revenue goes up. 64 00:05:58.680 --> 00:06:05.720 So this total revenue, this area here, which is twice times quantity, is greater than this. 65 00:06:05.720 --> 00:06:19.720 So the man curve is elastic if when price falls, price falls, total revenue increases. 66 00:06:19.720 --> 00:06:26.280 and demand curve is inelastic if when price falls, total revenue drops, so this would 67 00:06:26.280 --> 00:06:42.080 be elastic, and this would be inelastic, and it's inelastic if when price falls, total 68 00:06:42.080 --> 00:06:55.080 If the total revenue remains the same, in other words, if it's some online here, then it's called unitarily elasticity, unit elasticity. 69 00:06:55.080 --> 00:07:02.080 So this is unit, or elasticity equal to one. 70 00:07:02.080 --> 00:07:10.080 If price falls, total revenue remains the same. 71 00:07:10.080 --> 00:07:26.080 So in other words, we have a schedule here with this is price and this is quantity, and this price is $10, whatever it is, the item of the case or whatever, and quantity, so was $100, total revenue was $1000. 72 00:07:26.080 --> 00:07:38.080 The price goes down to $9, and quantity goes up to $120, this is $1080, and so that means the demand curve is elastic in that zone, in this region. 73 00:07:38.080 --> 00:07:50.080 If, on the other hand, it only goes up to $105, then it's $945. In that case, total revenue is inelastic. 74 00:07:50.080 --> 00:07:59.080 If the percentage change is exactly the same and it winds up at $1000, then it's the total revenue is unitarily elastic, or unit elasticity. 75 00:07:59.080 --> 00:08:03.080 Neither elastic nor inelastic. 76 00:08:03.080 --> 00:08:07.800 And we saw that the demand curves as they were drawn by economic textbooks, in economic 77 00:08:07.800 --> 00:08:12.440 textbooks, before 1943 approximately, were all like this, they were rectangular hyperbole, 78 00:08:12.440 --> 00:08:19.000 which means that the total revenue was always constant, never changed. 79 00:08:19.000 --> 00:08:23.720 And the way this got out of the textbook, it takes a lot to get something out of a textbook, 80 00:08:23.720 --> 00:08:28.080 once it's enshrined in a textbook, it takes almost dynamite to get it out. 81 00:08:28.080 --> 00:08:34.120 And Professor Stiegler, a later Nobel Prize winner in economics, said, well, why do they 82 00:08:34.120 --> 00:08:35.120 say this? 83 00:08:35.120 --> 00:08:36.120 There's no evidence for this nonsense. 84 00:08:36.120 --> 00:08:38.120 There's no evidence that total revenue remains the same. 85 00:08:38.120 --> 00:08:39.120 In fact, it probably changes. 86 00:08:39.120 --> 00:08:41.320 Why don't we make it a straight line? 87 00:08:41.320 --> 00:08:42.880 Ever since then, the man curves have been straight line. 88 00:08:42.880 --> 00:08:45.720 There's no evidence for that either, but at least it doesn't assume constant total revenue. 89 00:08:45.720 --> 00:08:51.000 At least you can see that there are changes that go up and down. 90 00:08:51.000 --> 00:08:54.600 So this is the most important property of the man curve, it's elasticity. 91 00:08:54.600 --> 00:08:59.000 And that depends whether total revenue goes up or down when the price changes. 92 00:08:59.000 --> 00:09:02.560 Of course, the exact opposite occurs when you go up and the price increases. 93 00:09:02.560 --> 00:09:07.400 In other words, in economics and microeconomics, it always changes the signs, so it's symmetrical. 94 00:09:07.400 --> 00:09:14.820 So this is, if the price goes up, elasticity, if the price increases, total revenue drops 95 00:09:14.820 --> 00:09:15.820 full. 96 00:09:15.820 --> 00:09:23.380 The exact opposite happens, you go up, in other words, you go up from here, price goes 97 00:09:23.380 --> 00:09:30.380 So it goes up from here to here. The total revenue drops as an elastic curve. The total revenue goes up as an inelastic curve. 98 00:09:30.380 --> 00:09:40.380 So again, you just reverse this. So if the price increases, the total revenue increases, then it's an inelastic demand curve. 99 00:09:40.380 --> 00:09:46.380 And similarly, of course, if the price increases and the total revenue remains the same, you still have your unit elastic range. 100 00:09:46.380 --> 00:09:53.380 In any given demand curve, the elasticity changes in the course of the curve, just because it's flat or steep doesn't necessarily mean it's elastic or anything like that. 101 00:09:53.380 --> 00:10:02.380 If you go down here, it might change. If you go up here, particularly, you might have a steep looking curve, but eventually, if you keep raising the price, it will become elastic. 102 00:10:02.380 --> 00:10:12.380 In other words, total revenue will start falling. If you increase the price of Wonder Bread at $20 a loaf or whatever, the total revenue suckers will spend on it will fall considerably. 103 00:10:12.380 --> 00:10:22.380 So you can't just look, the only time you can look at the flatness or steepness and say that's elasticity or elasticity is when you have the same point, referring to the same point. 104 00:10:26.380 --> 00:10:38.380 Okay, so that's the elasticity of demand, property of that, and then we went to, then we brought in the supply line, we now have elasticity of demand. 105 00:10:38.380 --> 00:10:43.380 Oh, one thing about the elasticity of the man, again, is that, you know, we don't know what the elasticity is. 106 00:10:43.380 --> 00:10:53.380 We do know the more range of choice, other things being equal, the greater the range of choice in the consumer or the buyer has, the more elastic the man curve will tend to be. 107 00:10:53.380 --> 00:11:04.380 So, in other words, if the price of Wonder Bread goes up from $1.00 a loaf to $1.50, all the other bread prices remain the same, there will be a tremendous falling off in purchase. 108 00:11:04.380 --> 00:11:08.500 The other hand, if all the bread prices go up, there'll be a falling off and not nearly 109 00:11:08.500 --> 00:11:11.140 as great because there won't be that range of choice. 110 00:11:11.140 --> 00:11:15.020 Consumers wouldn't be able to shift from Wonder Bread to Tasty Bread or Pepperidge Fond, they're 111 00:11:15.020 --> 00:11:16.020 all going up. 112 00:11:16.020 --> 00:11:18.980 You have to shift the rolls or whatever. 113 00:11:18.980 --> 00:11:24.180 So similarly here, if Wonder Bread is the only firm that cuts its price, you have a 114 00:11:24.180 --> 00:11:26.780 big increase in quantity purchased. 115 00:11:26.780 --> 00:11:31.420 If all the breads cut their prices, you'd have a small increase, not nearly as much. 116 00:11:31.420 --> 00:11:37.260 So the other thing we can say is that a man curve for the firm, the individual firm, is 117 00:11:37.260 --> 00:11:39.380 always greater than a man curve for the industry. 118 00:11:39.380 --> 00:11:42.140 Could be a little bit greater, could be a lot greater, we don't know, but we do know 119 00:11:42.140 --> 00:11:46.700 it will be more elastic, man curve for the firm, unless of course the industry has only 120 00:11:46.700 --> 00:11:50.580 one firm in it, it will become the same thing. 121 00:11:50.580 --> 00:11:57.300 So alright, then we move from that to the determination of price, the most important 122 00:11:57.300 --> 00:12:03.820 single item, single part of a course. How are prices in the market determined? In the 123 00:12:03.820 --> 00:12:09.540 market, of course, you have exchange of two commodities and two people. And every exchange 124 00:12:09.540 --> 00:12:13.980 is that sort of exchange. I'd buy a sandwich for whatever it is, a buck and a half or something. 125 00:12:13.980 --> 00:12:19.980 I'm exchanging a buck and a half for a sandwich. So this is price again on the y-axis, quantity 126 00:12:19.980 --> 00:12:24.660 x-axis. You have a demand curve for any given product, a fully demand curve, and you have 127 00:12:24.660 --> 00:12:32.660 In any given time you have a vertical supply line. In other words, you have a certain number of goods which are out there on the market ready to be sold today. 128 00:12:32.660 --> 00:12:42.660 Heads of lettuce, stereo sets, gears, whatever happens to be, or nails. There's a certain amount ready to be sold and a certain demand curve. 129 00:12:42.660 --> 00:12:51.660 And then what we maintain is that the day-to-day price on the market will be the intersection point between the demand curve and the supply line. 130 00:12:51.660 --> 00:13:00.460 and this will be the equilibrium price, any good or service. If the good or service differs 131 00:13:00.460 --> 00:13:04.180 from that, differs from the equilibrium, the forces of the market will immediately bring 132 00:13:04.180 --> 00:13:08.260 it back to that particular intersection point. That's why it's called equilibrium, because 133 00:13:08.260 --> 00:13:13.380 equilibrium physics is something that tends to rest at a certain point. If it's displaced 134 00:13:13.380 --> 00:13:17.640 from that point, it goes right back to it. Similarly, market forces bring it right back 135 00:13:17.640 --> 00:13:22.220 to the equilibrium point, market forces in this case being two things, one is a free 136 00:13:22.220 --> 00:13:27.640 price system, in other words, the price system is free to move, and two, desire a businessman 137 00:13:27.640 --> 00:13:30.640 to make profits and avoid losses, that's all you need, of course, all businessmen have 138 00:13:30.640 --> 00:13:34.440 that desire, otherwise, it wouldn't be a business very long, if they don't desire to avoid 139 00:13:34.440 --> 00:13:39.480 losses, for example, they'll lose a lot of money and be out of business. 140 00:13:39.480 --> 00:13:44.680 So then we saw that if the price, for example, is higher than the equilibrium point, then 141 00:13:44.680 --> 00:13:50.840 There will be a certain amount ready to be sold, much less of it, sellable to consumers. 142 00:13:50.840 --> 00:13:56.760 This will be an unsold surplus, which will pile up on a shelf, something which all businessmen 143 00:13:56.760 --> 00:14:01.480 hate like they're very dickens, like blazes, stuff they thought was going to sell and so 144 00:14:01.480 --> 00:14:03.480 it's piling up unsold. 145 00:14:03.480 --> 00:14:07.960 And then they find as they lower the price of it, lo and behold, more will be sold, so 146 00:14:07.960 --> 00:14:11.080 finally as they keep lowering it, surplus is over. 147 00:14:11.080 --> 00:14:18.080 So the way the market eliminates unsold surpluses by cutting the price as the price falls is to go back to the equilibrium point. 148 00:14:18.080 --> 00:14:28.080 Conversely, if the price is below the equilibrium point, there will then be a certain amount ready to be sold, but buyers or consumers will want to buy more than that. 149 00:14:28.080 --> 00:14:32.080 At that lower price, they want to buy this much. And this is a shortage. 150 00:14:32.080 --> 00:14:37.080 In other words, here you have an excess demand. Your demand is greater than supply at that price. 151 00:14:37.080 --> 00:14:41.080 shortage means that stuff disappears from the shelves and breaks rapidly 152 00:14:41.080 --> 00:14:45.080 and then businessmen say, hey, this means I can raise the price without worrying about cutting sales 153 00:14:45.080 --> 00:14:49.080 and as they raise the price the shortage becomes more and more over 154 00:14:49.080 --> 00:14:53.080 so finally you're back to the equilibrium point, no shortage and no surplus 155 00:14:53.080 --> 00:14:57.080 so below the equilibrium price 156 00:14:57.080 --> 00:15:01.080 demand is greater than supply, excess demand, above it, supply is greater than demand 157 00:15:01.080 --> 00:15:05.080 in other words, excess supply or surplus, only at this price 158 00:15:05.080 --> 00:15:10.560 What is this price, is the demand and supply equal, in other words, it's called clearing 159 00:15:10.560 --> 00:15:16.760 the market, where supply and demand are exactly equal, as much, as sold as the people want 160 00:15:16.760 --> 00:15:17.760 to sell. 161 00:15:17.760 --> 00:15:20.640 In other words, businessmen produce a certain amount, they want to sell it, and this is 162 00:15:20.640 --> 00:15:22.600 exactly the amount that the consumer is willing to buy. 163 00:15:22.600 --> 00:15:26.200 So this is the price which would be set to determine the market. 164 00:15:26.200 --> 00:15:30.600 This is, in other words, one of the great, one of the important things that shows this, 165 00:15:30.600 --> 00:15:34.840 that even though people who don't understand economics think that the market is chaotic, 166 00:15:34.840 --> 00:15:38.760 The prices are cat. Nobody knows why prices are set the way they are. It's all unplanned. 167 00:15:38.760 --> 00:15:42.320 There's no government planning board which says, okay, you and you produce this much 168 00:15:42.320 --> 00:15:45.960 and sell at that price. Instead of that, it works much better than government planning 169 00:15:45.960 --> 00:15:51.040 because it works smoothly and integrates and harmonizes the amount people want to pay for 170 00:15:51.040 --> 00:15:56.100 a product with the amount that people produce. It equates supply and demand. So every step 171 00:15:56.100 --> 00:16:00.960 of the way, either in consumer goods or producer's goods or raw materials or like mining coal, 172 00:16:00.960 --> 00:16:06.960 or whatever it is, there's never any shortage or any surplus. There's always an equation of demand and supply. 173 00:16:06.960 --> 00:16:14.960 Even though the individuals on the market don't realize this, don't talk about equating supply and demand, that's the way it works in practice. 174 00:16:14.960 --> 00:16:21.960 That's why Adam Smith says the market works as if there's an invisible hand harmonizing everything. 175 00:16:21.960 --> 00:16:25.960 It doesn't mean there isn't an invisible hand, it just means that's the way it works. 176 00:16:25.960 --> 00:16:29.960 Okay, if the price tends to be set at this particular point, what can change it then? 177 00:16:29.960 --> 00:16:32.960 If there's an equilibrium price, why do prices change all the time? 178 00:16:32.960 --> 00:16:37.960 And the answer there is, of course, that either supply changes or demand curve changes. 179 00:16:37.960 --> 00:16:41.960 Those are the only two things that can change prices. We'll see later on. 180 00:16:41.960 --> 00:16:46.960 A cost, an increase in cost, cannot increase price. It only does it through cutting supply, 181 00:16:46.960 --> 00:16:53.960 because these are the only two factors that go into a price determining price. 182 00:16:53.960 --> 00:17:08.960 So, if the supply changes, let's say if there is a coffee frost, right now there is a coffee blight, a drought in Brazil. Usually there is a frost every few years. This time there is a big drought. The coffee prices will go up imminently. 183 00:17:08.960 --> 00:17:14.960 And, in other words, you then have a big drop in supply, supply curve shifts to the left. 184 00:17:14.960 --> 00:17:21.960 It means that the old equilibrium price is now a shortage, demand is not greater than supply. 185 00:17:21.960 --> 00:17:27.960 Prices therefore go up, you wind up with an old equilibrium price, a higher price, which clears the market. 186 00:17:27.960 --> 00:17:36.960 So, a decrease in supply, a decrease in supply of X, means an increase in price of X. 187 00:17:36.960 --> 00:17:41.760 This shows how prices perform a rationing function. Prices perform two important functions. 188 00:17:41.760 --> 00:17:46.560 One is a rationing function, rationing the scarcity. If the scarcity is greater, price 189 00:17:46.560 --> 00:17:51.120 goes up. If the scarcity is less, the price is cheaper, down to the point where if goods 190 00:17:51.120 --> 00:17:54.640 are super abundant, like air, then the price is free. You don't have to worry about it, 191 00:17:54.640 --> 00:18:00.320 it's always there. So the greater the... Do you have a question? No. The greater the 192 00:18:00.320 --> 00:18:04.160 The results of scarcity are greater than the price. 193 00:18:04.160 --> 00:18:10.320 Conversely, if the coffee crop is finally adjusted, however, it comes back in a normal 194 00:18:10.320 --> 00:18:15.440 situation, then you have an increase in the supply. 195 00:18:15.440 --> 00:18:18.320 At the old equilibrium price, you don't have a surplus. 196 00:18:18.320 --> 00:18:24.720 In order to induce people to buy more of the coffee, you have to lower the price. 197 00:18:24.720 --> 00:18:27.880 As the price is lowered, you eliminate the surplus, you wind up with a new equilibrium 198 00:18:27.880 --> 00:18:30.880 and the Rationing price, where the supply is greater and the price is lower. 199 00:18:30.880 --> 00:18:36.880 In other words, scarcity is less now, and therefore the rationing thing becomes less intense. 200 00:18:36.880 --> 00:18:40.880 An increase in the supply leads to a drop in price. 201 00:18:44.880 --> 00:18:51.880 Now, over time, most goods in a free market economy, goods tend to increase as you have increased capital investment and better technology. 202 00:18:51.880 --> 00:18:55.880 Most goods, supply tends to increase, so prices tend to fall. 203 00:18:55.880 --> 00:19:00.000 In other words, the general trend is of falling prices. 204 00:19:00.000 --> 00:19:03.880 You can see that dramatically in areas where you have tremendous increase in productivity. 205 00:19:03.880 --> 00:19:10.480 A few years, computers, calculators, TV sets, things like that, where prices are falling 206 00:19:10.480 --> 00:19:14.520 even though you have a general inflation, a teak of general inflation, which means the 207 00:19:14.520 --> 00:19:19.600 real prices, in other words, prices in terms of the price level of the whole, are falling 208 00:19:19.600 --> 00:19:23.360 even more than you might think. 209 00:19:23.360 --> 00:19:27.240 And if you consider per unit quality, which is the way you really have to think of prices, 210 00:19:27.240 --> 00:19:35.880 because a good is homogeneous, remember if we define a good as n homogeneous units, supply 211 00:19:35.880 --> 00:19:42.160 of a good, sorry, which means that n homogeneous units, so in order to be really homogeneous 212 00:19:42.160 --> 00:19:44.000 you have to have the same quality. 213 00:19:44.000 --> 00:19:49.360 Usually in the market economy the quality improves all the time, matter of fact, except 214 00:19:49.360 --> 00:20:19.360 for Government. In the private capitalist sector, quality of goods are always going up, and the quality of TV sets are much better than they used to be, the quality of computers and all sorts of stuff, so the price fall is much greater than you might think, because it's a tremendous fall per unit, price fall per unit quality, and only in government sector, I think the quality is always going down, like the post office. Beloved post office used to have, used to deliver mail twice a day, it's now once a day, if that. So not only are prices going up, not only are the prices of stamps going up, 215 00:20:19.360 --> 00:20:23.360 So the quality goes down with government. 216 00:20:23.360 --> 00:20:29.360 So that's the supply side of the situation. 217 00:20:29.360 --> 00:20:33.360 If you ask the question, if prices are always tending to go down, how come prices are always 218 00:20:33.360 --> 00:20:36.360 going up in general, the answer is the macro course. 219 00:20:36.360 --> 00:20:40.360 You learn that next term or whatever, because government keeps pouring more money into the 220 00:20:40.360 --> 00:20:41.360 system. 221 00:20:41.360 --> 00:20:42.360 In other words, government is like a vast counterfeiter. 222 00:20:42.360 --> 00:20:44.360 It's like it is a vast counterfeiter. 223 00:20:44.360 --> 00:20:46.360 It just prints money all the time and creates more money. 224 00:20:46.360 --> 00:20:50.360 more money. As it creates more money, of course, prices tend to go up. As greater demand, known 225 00:20:50.360 --> 00:20:54.360 as demand curves go up, everybody's got more money in their pockets than they had before, 226 00:20:54.360 --> 00:20:58.360 which tends to offset the fallen prices due to increased productivity. 227 00:20:58.360 --> 00:21:02.360 Okay, so that's the supply side. We now get to demand. 228 00:21:02.360 --> 00:21:06.360 What can increase the demand curve? Change the demand curve. 229 00:21:06.360 --> 00:21:10.360 And when we talk about demand increasing or decreasing, we mean the entire curve shifting up 230 00:21:10.360 --> 00:21:14.360 or down. And again, I'm going to repeat this again for the nth time. 231 00:21:14.360 --> 00:21:21.360 We should not confuse going down or up, given the man curve, with a change in the whole curve. 232 00:21:21.360 --> 00:21:26.360 When the supply increases, the price goes down, the quantity demanded goes up. 233 00:21:26.360 --> 00:21:30.360 In other words, the quantity produced and sold goes up. 234 00:21:30.360 --> 00:21:34.360 The quantity demanded goes up, but the entire demand curve does not go up, it doesn't change. 235 00:21:34.360 --> 00:21:40.360 The reason it doesn't change is the man curve is defined as the locus of what happens when prices change. 236 00:21:40.360 --> 00:21:43.360 In other words, you have a certain amount at any given price, how much will be purchased. 237 00:21:43.360 --> 00:21:48.440 So, if the price falls, unless you say the man curve is going to change, which there's 238 00:21:48.440 --> 00:21:52.840 no reason why it should, as the price falls, the quantity of demand that goes up as the 239 00:21:52.840 --> 00:21:55.360 man curve as a whole remains constant. 240 00:21:55.360 --> 00:21:56.360 The man curve remains constant. 241 00:21:56.360 --> 00:21:58.880 You're going down the given the man curve. 242 00:21:58.880 --> 00:22:02.160 The only thing which cannot increase the demand curve is the change in price. 243 00:22:02.160 --> 00:22:05.920 The only thing which can't cut the demand curve is the change in price, because the 244 00:22:05.920 --> 00:22:12.120 demand curve is defined as response to prices. 245 00:22:12.120 --> 00:22:15.600 So in other words, when a man curve goes up, why should a man curve go up? 246 00:22:15.600 --> 00:22:19.640 Well, it can go up for many reasons, either because the government prints more money, 247 00:22:19.640 --> 00:22:21.840 everybody's got more money in their pocket. 248 00:22:21.840 --> 00:22:22.840 One reason to go up. 249 00:22:22.840 --> 00:22:27.360 The man curve going up means, technically, at any given price, more will be purchased 250 00:22:27.360 --> 00:22:28.360 than before. 251 00:22:28.360 --> 00:22:33.800 Whatever the price is, there's an increase in purchases. 252 00:22:33.800 --> 00:22:39.200 So if everybody's got more money, if the government prints a lot of money and distributes it around, 253 00:22:39.200 --> 00:22:44.200 by spending, by lending it out and ripples through the system, then demand curve will shift upward. 254 00:22:44.200 --> 00:22:50.200 Or if there's a big tax cut, let's say, we'll have more money in our pockets, demand curve will shift upward. 255 00:22:50.200 --> 00:22:58.200 That's one reason for general curve to shift upward. For individual items, it's due to changes in taste, changes in fashion, changes in values. 256 00:22:58.200 --> 00:23:03.200 There's all sorts of value changes. It can be important or it could be frivolous. Economists don't worry about that. 257 00:23:03.200 --> 00:23:08.200 It's up to moralists and whatever, social psychologists, whatever it is. 258 00:23:08.200 --> 00:23:12.200 All we register is the fact that demand curves go up or down. Values change. 259 00:23:12.200 --> 00:23:20.200 For example, it used to be that the big game around here, outdoor game, was hula hoops. 260 00:23:20.200 --> 00:23:25.200 Big fan of hula hoops one year. And everybody bought hula hoops. Big increase in demand for hula hoops. 261 00:23:25.200 --> 00:23:30.200 And then hula hoops dropped out of Frisbee's comment. Big Frisbee boom, which I think is probably still going on in Frisbee. 262 00:23:30.200 --> 00:23:32.200 I don't know. I'm not really up on all of this. 263 00:23:32.200 --> 00:23:39.200 At any rate, and then of course a couple of years ago came the famous cabbage patch doll caper 264 00:23:39.200 --> 00:23:45.200 I mean they've been making dolls for hundreds of years and nobody got excited all of a sudden cabbage patch doll, that was it 265 00:23:45.200 --> 00:23:51.200 One guy flew to London to buy it because in London they hadn't had this big cabbage patch doll, boom 266 00:23:51.200 --> 00:23:59.200 So he had his weight paid for, I think his wife was a travel agent or something like that, or a steward 267 00:23:59.200 --> 00:24:04.200 The still and old is obviously very expensive to schlep the London of my doll for Christmas. 268 00:24:04.200 --> 00:24:09.200 It's still going on and the question for the Cabbage Patch doll people is, will this continue? 269 00:24:09.200 --> 00:24:14.200 Is it a flash in the panel? They have to figure it out. They have to play their hunches, their insight on the market, whatever it is. 270 00:24:14.200 --> 00:24:25.200 Again, as I mentioned, there's been a big shift in values over the last 40 years or so, out of pork and into beef, 271 00:24:25.200 --> 00:24:41.200 So these are shifts up and down. In some cases, the drop in decreases in the man curve. In other cases, it increases. 272 00:24:41.200 --> 00:24:48.200 So when the man curve increases, there's a rise in price. 273 00:24:48.200 --> 00:24:55.200 In other words, at the old price, it means the old price is now a shortage, prices are bid up until we get to the higher price. 274 00:24:55.200 --> 00:25:05.200 When the demand curve falls, there's a drop in, drop in means that the old price is now a surplus, people don't want to buy anymore. 275 00:25:05.200 --> 00:25:12.200 And so, there's a price fall to induce people to buy the available supply, and the price goes down. 276 00:25:12.200 --> 00:25:17.520 Then we get into the fact that as demand changes, if the demand is considered, change is considered 277 00:25:17.520 --> 00:25:21.480 fairly permanent, then there will be a change in supply, supply in the long run in response 278 00:25:21.480 --> 00:25:22.480 to demand. 279 00:25:22.480 --> 00:25:27.160 So in other words, if there's an increase in the demand curve for vodka, then people 280 00:25:27.160 --> 00:25:29.960 realize that the vodka makers, okay, we're going to get out of bourbon, out of bourbon, 281 00:25:29.960 --> 00:25:34.520 we're going to get into more and more vodka, and as they do that, depending on the technology, 282 00:25:34.520 --> 00:25:38.680 how long this takes, it all depends on the individual item, they'll start increasing 283 00:25:38.680 --> 00:25:47.680 and so over the years you get something like this, you get a price which is somewhere in between, usually between the old and the suddenly increased price. 284 00:25:47.680 --> 00:25:52.680 So you wind up then with a higher price perhaps and a greater output. 285 00:25:52.680 --> 00:26:06.680 In the case of a fall in the man curve, you wind up, you have a big drop in the man for bourbon and people get, producers get out of bourbon, and we're going to produce less of that. 286 00:26:06.680 --> 00:26:12.800 Over the years, we have a lower production and a higher price from the original, somewhere 287 00:26:12.800 --> 00:26:13.800 in between again. 288 00:26:13.800 --> 00:26:18.040 So in this way, consumers over the long run, because we didn't see, first we talked about 289 00:26:18.040 --> 00:26:21.520 a given supply line, well then we start talking about what determines the supply line, it's 290 00:26:21.520 --> 00:26:22.520 not God given. 291 00:26:22.520 --> 00:26:27.120 It was due to previous decisions by producers, you know, six months ago, a year ago, five 292 00:26:27.120 --> 00:26:29.120 years ago, whatever, depending on the good. 293 00:26:29.120 --> 00:26:34.040 In the case of liquor or wine, particularly, it takes many years of course of wine to ripen 294 00:26:34.040 --> 00:26:35.040 and stuff like that. 295 00:26:35.040 --> 00:26:38.900 Anyway, over the long run, then you get in the situation where if an increased demand 296 00:26:38.900 --> 00:26:44.200 will then induce a greater supply of the product, a lower demand will cause a lower supply of 297 00:26:44.200 --> 00:26:45.200 the product. 298 00:26:45.200 --> 00:26:49.200 So in that way, supply, production, response, and consumer demand. 299 00:26:49.200 --> 00:26:52.240 And a greater demand will cause greater output and vice versa. 300 00:26:52.240 --> 00:26:56.280 Except of course in goods which are output are fixed forever, like Rembrandt paintings. 301 00:26:56.280 --> 00:27:01.360 And see, you've got a perfect forgery, which these days of technology is almost impossible 302 00:27:01.360 --> 00:27:04.720 because they can date stuff, things like that. 303 00:27:04.720 --> 00:27:10.720 Supply of Rembrandt is gone with Rembrandt. It's absolutely fixed. It certainly can't be increased. 304 00:27:10.720 --> 00:27:15.720 Once in a while you can lose a painting or somebody can destroy it, but you cannot increase. 305 00:27:15.720 --> 00:27:22.720 So anyway, in that way, supply and the market production responds to consumer demand. 306 00:27:22.720 --> 00:27:27.720 First is what people expect consumer demand will be, and then if the producers are right, 307 00:27:27.720 --> 00:27:32.720 if demand is increased, then they'll make profits, this will spur them to make even more of them. 308 00:27:32.720 --> 00:27:38.720 If they're wrong, it turns out that the increased demand for a vodka was only temporary and they lose a lot of money and all is cut back. 309 00:27:38.720 --> 00:27:43.720 So in other words, profits and losses are signals to producers whether they're on the right track or not. 310 00:27:43.720 --> 00:27:47.720 They make higher profits, they'll increase the production. 311 00:27:47.720 --> 00:27:50.720 They make lower profits or losses, then they'll cut back. 312 00:27:50.720 --> 00:27:55.720 So the profits are like a signal whether they're on the right track at serving consumers or not. 313 00:27:55.720 --> 00:28:10.720 And later, after the midterm, we'll get into the theory of a firm, part three, and we'll start talking about costs and production and how production is determined and how it profits, things like that. 314 00:28:10.720 --> 00:28:18.720 Okay, so that sort of covered any given good. Then we went into relationships between goods. 315 00:28:25.720 --> 00:28:42.720 The two major ones are substitutability, co-substitutes, or goods and substitutes for each other fulfilling the same market. 316 00:28:42.720 --> 00:28:53.720 Coffee and tea, cocoa and tea, metals, aluminum and steel, all these things can feel more or less the same. 317 00:28:53.720 --> 00:28:56.840 not perfect substitutes, but they're fairly close. 318 00:28:56.840 --> 00:29:02.700 So what happens, for example, when the supply curve of coffee went down, and coffee became 319 00:29:02.700 --> 00:29:06.600 more scarce and more expensive, people shifted more and more to tea and cocoa. 320 00:29:06.600 --> 00:29:14.560 So you then have a, as a result of this, an increase in demand curve for tea, let's say, 321 00:29:14.560 --> 00:29:20.440 and the price of tea tended to go up, and cocoa the same way. 322 00:29:20.440 --> 00:29:30.160 So we can then say that the decrease in supply of x brings about an increase in price. 323 00:29:30.160 --> 00:29:36.680 This increase in price will in turn bring about an increase in demand for y, the substitute, 324 00:29:36.680 --> 00:29:38.160 which in turn will raise the price of y. 325 00:29:38.160 --> 00:29:45.040 It's separate, separate, you can just change the sign and get the same thing. 326 00:29:45.040 --> 00:29:49.520 An increase in supply of x causes a drop in the price of x, causes a drop in the demand 327 00:29:49.520 --> 00:29:58.520 and why a drop in the price. As coffee gets cheaper, let's say, people will shift out of tea into coffee and the demand curve for tea will go down, the price of tea will fall. 328 00:29:58.520 --> 00:30:03.520 Eventually, of course, the output in the long run. 329 00:30:03.520 --> 00:30:08.520 Okay, then there's compliments. 330 00:30:08.520 --> 00:30:17.520 A compliment is two goods go together. Instead of being substitutes, sort of battling each other, a compliment and they go together. They're either demanded together or produced together. 331 00:30:17.520 --> 00:30:32.520 The case of joint demand, cases like ham and eggs, or steak and steak sauce, or bread and butter, things like that, which are demanded together, or baseball caps, baseball gloves, you know, all the rest of it. 332 00:30:32.520 --> 00:30:37.520 Or factors that go into labor and capital and land go into a certain production. 333 00:30:37.520 --> 00:30:44.520 If demand for champagne goes up, you have an increase in demand for champagne labor, an increase in demand for champagne machinery and champagne land. 334 00:30:44.520 --> 00:30:50.520 All these things will increase. The prices will go up. Wage rates will go up. Champagne, country, and so forth and so on. 335 00:30:50.520 --> 00:30:52.520 So these are joint demands. 336 00:30:52.520 --> 00:30:59.520 And one interesting thing there is what happens when the supply changes in one of these factors. 337 00:30:59.520 --> 00:31:03.520 In other words, they say bread and butter for sandwiches. 338 00:31:03.520 --> 00:31:09.520 They say bread and butter is only for sandwiches. 339 00:31:09.520 --> 00:31:17.520 If the price of butter gets cheaper, spectacularly cheaper because of an increase in productivity or fertilizer or whatever, 340 00:31:17.520 --> 00:31:21.520 then the price will fall, increase in supply of X. 341 00:31:21.520 --> 00:31:28.520 And this will make sandwiches cheaper, and the result of that will be an increase in demand for bread, and with more sandwiches being purchased. 342 00:31:28.520 --> 00:31:36.520 But bread hasn't gotten cheaper. I mean, bread has the same supply as before, so the price of bread will go up. 343 00:31:36.520 --> 00:31:49.520 So this causes an increase in demand for Y, and an increase in the price of Y, and you have, with joint, there's a joint demand, this is what happens. 344 00:31:53.520 --> 00:31:54.520 Or complements. 345 00:31:55.520 --> 00:32:02.520 Of course, again, the sign is reversed, if the supply goes down for butter, let's say there's a big cow shortage or something like that, 346 00:32:02.520 --> 00:32:09.520 The price goes up, which means that the man for sandwiches goes down, which means that the man for bread goes down, and the price of bread goes down. 347 00:32:09.520 --> 00:32:17.520 In both cases, the prices are going in opposite directions here, between the two factors, when the supply is the source of the change. 348 00:32:17.520 --> 00:32:22.520 When the man is the source of change, it's easy to see what happens. All the man curves go up or go down, and that's it. 349 00:32:22.520 --> 00:32:25.520 In the case of supply, however, it gets a little trickier. 350 00:32:25.520 --> 00:32:34.520 And the other jointness, the other component was joint supply, where two goods are simply produced together and are found together in nature. 351 00:32:34.520 --> 00:32:42.520 Beef and hides are the famous example. Beef cattle are killed for meat and also of course there's skin which is used for leather, hides or leather. 352 00:32:42.520 --> 00:32:49.520 And same way with copper and silver which are found together and so forth and so on. 353 00:32:49.520 --> 00:33:11.520 Here what happens is that you have a response. In other words, when there's an increase in demand for beef over time, and the demand curve goes up, supply then goes up in the long run, and you get then, as a result of that, an increase in the supply of hides or leather, which causes a drop in the price. 354 00:33:11.520 --> 00:33:24.640 In other words, demand for x goes up, increase demand for beef, let's say, and this increases 355 00:33:24.640 --> 00:33:31.440 the price, which in turn increases the supply of x in the long run. 356 00:33:31.440 --> 00:33:36.120 And this in turn increases the supply of y, which lowers the price of y. 357 00:33:36.120 --> 00:33:49.760 This finishes the relationship between goods and then we talk about what happens when the 358 00:33:49.760 --> 00:33:53.400 government interferes in this process, a whole bunch of case studies about that. 359 00:33:53.400 --> 00:33:57.080 This can be summed up as either maximum price control or minimum price control. 360 00:33:57.080 --> 00:34:01.400 We always talk about cartels a little bit, but that's not going to be after the midterm. 361 00:34:01.400 --> 00:34:14.320 In maximum price control, which is more common, a government orders that you can't sell above 362 00:34:14.320 --> 00:34:18.820 a certain price, which is below the market equilibrium price. 363 00:34:18.820 --> 00:34:24.960 This is the maximum price control, which puts the price to lower the price below the equilibrium 364 00:34:24.960 --> 00:34:25.960 by force. 365 00:34:25.960 --> 00:34:32.200 Putting a floor on it, a ceiling on it, excuse me, on preventing it from going up. 366 00:34:32.200 --> 00:34:36.000 One of the situations we saw that caused all sorts of problems, the first thing that caused 367 00:34:36.000 --> 00:34:41.720 a shortage, it means the shortage cannot be eliminated in the market, you have a permanent 368 00:34:41.720 --> 00:34:47.280 shortage which gets worse over time as the supply goes down, there's an unprofitability 369 00:34:47.280 --> 00:34:50.120 of the whole product. 370 00:34:50.120 --> 00:34:53.720 And then you have black markets, which are very high prices, they're very scarce, they 371 00:34:53.720 --> 00:34:56.360 They can't advertise, they have to pay off the cops and all that. 372 00:34:56.360 --> 00:35:04.000 You have like a small black market around the edges and a decline in rationing through 373 00:35:04.000 --> 00:35:08.120 lining up, so being on a waiting list or standing in line, because this has to be rationed in 374 00:35:08.120 --> 00:35:09.120 some way. 375 00:35:09.120 --> 00:35:11.680 If the price system can't ration, it's got to be done through coercion, through ration 376 00:35:11.680 --> 00:35:17.800 tickets and or standing in line through favoritism, through the producer taking over racial and 377 00:35:17.800 --> 00:35:21.720 religious discrimination because the producer is in the saloon, he doesn't have to worry 378 00:35:21.720 --> 00:35:26.000 about customers, there are plenty, there are too many customers and they can ration customers 379 00:35:26.000 --> 00:35:29.040 and say, okay, I like this guy and this guy, this guy is my brother-in-law, this guy is 380 00:35:29.040 --> 00:35:32.080 not the same race as I am and how about everybody else? 381 00:35:32.080 --> 00:35:36.560 So this is, these are all, and also the decline in quality, a hidden price increase is the 382 00:35:36.560 --> 00:35:40.720 quality of the crime which cannot be policed, it's almost impossible except for certain 383 00:35:40.720 --> 00:35:45.520 visible things, but police the decline in quality, figure out is there really less almonds 384 00:35:45.520 --> 00:35:49.140 now than there used to be in the chocolate almond crunch ice cream. 385 00:35:49.140 --> 00:35:55.900 So, and of course it doesn't really cure inflation, usually the maximum price of inflation doesn't 386 00:35:55.900 --> 00:35:58.420 do that at all, it simply makes things worse. 387 00:35:58.420 --> 00:36:01.580 Inflation is caused by an increase in demand curves due to an increase in money supply, 388 00:36:01.580 --> 00:36:05.740 which keeps bubbling more and more merrily anyway. 389 00:36:05.740 --> 00:36:11.180 In minimum price control, the government keeps the price above the equilibrium point, free 390 00:36:11.180 --> 00:36:16.020 market equilibrium, and this perpetuates a surplus, in other words, instead of the surplus 391 00:36:16.020 --> 00:36:25.020 are being eliminated quickly to the price system, but now this is the minimum price on the price floor, perpetuates unsold surplus. 392 00:36:25.020 --> 00:36:29.020 In many cases, the surplus gets worse over time because the producer can produce more of it. 393 00:36:29.020 --> 00:36:34.020 Hey, the price is pretty good here, and calls for an even greater surplus that the government has to handle in some way. 394 00:36:34.020 --> 00:36:41.020 Two big examples of this are the farm price support program, which is a total mess and getting worse, 395 00:36:41.020 --> 00:36:49.020 As the surpluses keep piling up, the minimum wage laws create unemployment among the lowest paid workers. 396 00:36:49.020 --> 00:36:56.020 Examples of maximum price control are legion, there's not only things like meat control, World War II, and all sorts of other things, 397 00:36:56.020 --> 00:37:06.020 there's also the water shortage caused by water price control, the traffic ingestion caused by the price of traffic, so to speak, being virtually zero, 398 00:37:06.020 --> 00:37:13.020 and all sorts of other stuff, rent control which causes housing shortage, apartment shortage 399 00:37:13.540 --> 00:37:19.740 and causes all sorts of ways to try to evade the regulations. And all these things are examples 400 00:37:19.740 --> 00:37:25.740 of price control that's all in action. That really, I guess, sums up the course. I don't 401 00:37:25.740 --> 00:37:30.740 have much time for questions. Any questions on any part of the course? Any other stuff? 402 00:37:30.740 --> 00:37:43.740 Well, I just got back from Europe, so I haven't seen the exams yet. I will mark them by Thursday and give them back. 403 00:37:43.740 --> 00:37:51.740 I went to Europe. Well, I went to Poland, the conference in Poland and London and toured around the continent a bit. 404 00:37:51.740 --> 00:37:55.740 Basically, it was a Polish conference. 405 00:37:55.740 --> 00:38:04.740 No, no, our school? Good heavens, no. Just be kidding. No, this was financed from London, 406 00:38:04.740 --> 00:38:11.740 organized from London, and so the Polish scholars there all against the government. It was heroic. 407 00:38:11.740 --> 00:38:17.740 It was very openly, even though it was probably an apparatchik spy and they didn't care. 408 00:38:17.740 --> 00:38:23.740 No, apparently they're very outspoken. There are no Polish intellectuals in favor of the government now. 409 00:38:23.740 --> 00:38:31.740 So it's sort of like a peculiar kind of equilibrium, as they said, that they were, that they, they just, the government realized that they didn't do anything about it. 410 00:38:31.740 --> 00:38:39.740 So it's a very odd situation. It's probably, apparently this is the only place in Eastern Europe where they could have had a conference of this sort. 411 00:38:39.740 --> 00:38:47.740 Even in Hungary, where they, which is much freer economically, is not as intellectually free. So that was very interesting. 412 00:38:47.740 --> 00:38:55.740 So, anyway, it was heartwarming to see. I mean, the whole country is sort of falling apart, but at least they're intellectually in good shape. 413 00:38:55.740 --> 00:39:05.740 No, you can't get any wonder bread. You can't get any American or English papers either, so it's kind of a news blackout. 414 00:39:05.740 --> 00:39:16.780 At any rate, to return to our mutton theory, we're into the theory of the firm, and the 415 00:39:16.780 --> 00:39:21.740 objective of each firm is to maximize their profits, rather than have as high a profit 416 00:39:21.740 --> 00:39:25.060 as they can to avoid losses. 417 00:39:25.060 --> 00:39:32.300 Profits are equal to total revenue minus total cost, in other words, over a year period let's 418 00:39:32.300 --> 00:39:40.300 Let's say you take any time period, the money you take in minus the money you pay out, and this of course gets very complicated in practice, but in theory it's pretty simple to understand. 419 00:39:40.300 --> 00:39:48.300 If you take in 1.5 million dollars and you pay out 1.0 million, then you have a profit of 500,000. 420 00:39:48.300 --> 00:39:58.300 If you unfortunately pay out a million dollars and take in only 0.5, then you have losses of 500,000 dollars. 421 00:39:58.300 --> 00:40:03.820 So, everybody is trying to, every business firm, business entity tries to maximize their 422 00:40:03.820 --> 00:40:06.300 profits, increase their profits and avoid losses. 423 00:40:06.300 --> 00:40:12.220 They can't always do that, losses often pop up, largely because the costs are paid out 424 00:40:12.220 --> 00:40:16.780 immediately before the money is taken in, in other words, you have to build your plant, 425 00:40:16.780 --> 00:40:21.660 whatever it is, you have to hire your workers, buy raw material, get all the stuff together 426 00:40:21.660 --> 00:40:26.220 and then try to sell the product and then try to sell the product at a profit. 427 00:40:26.220 --> 00:40:30.140 So the payout comes now, and the income comes later, and there's also, of course, a big 428 00:40:30.140 --> 00:40:35.780 slip here. Consumers don't always do what the, or buyers don't always do what the investors 429 00:40:35.780 --> 00:40:39.260 think they're going to do. So they often make losses, and they try, of course, very hard 430 00:40:39.260 --> 00:40:48.700 not to. And so this is the, and this goal of trying to maximize profits and avoid losses 431 00:40:48.700 --> 00:40:54.060 drives the whole economic free market system, and it equilibrates everything. It equilibrates 432 00:40:54.060 --> 00:40:56.900 It's applying to man as we saw on the first part of the course at each step of the way 433 00:40:56.900 --> 00:40:59.900 because everybody is trying to increase profits and avoid losses. 434 00:40:59.900 --> 00:41:04.820 It's a very simple but effective motivation on the part of a businessman, especially in 435 00:41:04.820 --> 00:41:07.660 the fact that the businessman has already paid out the money and doesn't want to lose it. 436 00:41:07.660 --> 00:41:11.020 It's a very powerful incentive. 437 00:41:11.020 --> 00:41:18.500 There's been questions, not so much about economists, some economists, a small minority, 438 00:41:18.500 --> 00:41:25.660 Mostly among intellectual sociologists, people of that ilk, writers, literary types, claiming 439 00:41:25.660 --> 00:41:31.180 that, well, maybe it's true in the 19th century that business firms wanted to maximize profits, 440 00:41:31.180 --> 00:41:32.300 but now it's not true anymore. 441 00:41:32.300 --> 00:41:36.980 Now the managers have taken over, and managers don't care about profits, so they just want 442 00:41:36.980 --> 00:41:40.340 to have a minimal amount. 443 00:41:40.340 --> 00:41:45.540 They want to increase the size of their operations, they want a quiet life, etc., etc. 444 00:41:45.540 --> 00:41:47.340 Most of this is generally a lot of nonsense. 445 00:41:47.340 --> 00:41:49.240 As a matter of fact, it works the other way around. 446 00:41:49.240 --> 00:41:54.540 As the corporation gets bigger, there's less and less of the sort of mom and pop kind of 447 00:41:54.540 --> 00:41:55.540 motivation. 448 00:41:55.540 --> 00:42:01.900 In other words, if you own a grocery store with two employees, your wife might persuade 449 00:42:01.900 --> 00:42:04.100 you to hire your incompetent brother-in-law. 450 00:42:04.100 --> 00:42:07.220 You know he's incompetent, he's losing money for you, but still in order to keep peace 451 00:42:07.220 --> 00:42:08.500 in the family, hire him anyway. 452 00:42:08.500 --> 00:42:11.060 So a lot of that goes on in family businesses. 453 00:42:11.060 --> 00:42:16.540 But with a corporation, as the firms get larger and get incorporated, there's much less of 454 00:42:16.540 --> 00:42:20.540 There's some of that, of course, but much less of it, because you have to satisfy the stockholders. 455 00:42:20.540 --> 00:42:23.540 You haven't got sort of a personal operation anymore. 456 00:42:23.540 --> 00:42:29.540 So the drive for maximizing money profits is even stronger in corporations than it is with personal firms. 457 00:42:29.540 --> 00:42:32.540 But it's also a drive to keep peace. 458 00:42:32.540 --> 00:42:34.540 Private utility takes over. 459 00:42:34.540 --> 00:42:38.540 Psychic utility, in some cases, is more important than money profit. 460 00:42:38.540 --> 00:42:43.540 Obviously, you can't make losses, because then you go out of business. 461 00:42:43.540 --> 00:42:52.540 So, the drive for maximizing money and profits is even stronger with corporations than it is with personal mom-and-pop firms, so to speak. 462 00:42:52.540 --> 00:43:03.540 The idea that managers have taken over, which came out with a famous book by Burley and Means to new dealers in 1930, I think it was, 463 00:43:03.540 --> 00:43:08.540 was called The Modern Corporation of Private Property, a very famous book. 464 00:43:08.540 --> 00:43:15.540 They were neither, well Means, I guess, was sort of an economist, although I sort of questioned it. Burleigh was a corporate lawyer. 465 00:43:15.540 --> 00:43:22.540 Their thesis was that in modern corporate firms, the managers are taken over. Stockholders are no longer important. They don't count. 466 00:43:22.540 --> 00:43:35.540 The managers sort of seize power. And what they want is essentially increasing the size of the company, or they don't care much about profits, status, whatever the motivations are. 467 00:43:35.540 --> 00:43:42.660 Now this I think is refutable fairly easily, it's true that managers often don't care 468 00:43:42.660 --> 00:43:49.500 that much about profits, on the other hand, if they don't make profits, if their earning 469 00:43:49.500 --> 00:43:53.860 ratio doesn't look too hot, the stockholders first of all get sore, and getting sore doesn't 470 00:43:53.860 --> 00:43:58.300 necessarily mean they'll kick them out, it is difficult to kick out managers, you know, 471 00:43:58.300 --> 00:44:01.860 there's like a little political machine, the stockholders have to get together and 472 00:44:01.860 --> 00:44:07.700 Organizers, there's a lot of them, there's maybe 2 million stockholders in some big corporation. 473 00:44:07.700 --> 00:44:08.700 They don't have to organize. 474 00:44:08.700 --> 00:44:12.380 The interesting thing about a corporation is all the stockholders have to do to exert 475 00:44:12.380 --> 00:44:15.380 their power is to vote with their pocketbook, in other words, sell the stock. 476 00:44:15.380 --> 00:44:20.380 So if you own 10 shares or 100 shares of General Motors stock, you think General Motors is 477 00:44:20.380 --> 00:44:22.500 not doing very well, its profits are low, it's... 478 00:44:22.500 --> 00:44:24.700 We just sell the stock and buy something else. 479 00:44:24.700 --> 00:44:28.540 The act of selling the stock drives down the price of the stock and makes the managers 480 00:44:28.540 --> 00:44:33.540 The stockholders are very upset because they don't like the fact that the value of their stock is going down. 481 00:44:33.540 --> 00:44:38.540 Also, selling of the stock is sort of a key thing here. 482 00:44:38.540 --> 00:44:43.540 So long before the stockholders start organizing to kick out the managers and get somebody else in, 483 00:44:43.540 --> 00:44:46.540 they sell the stock and the value of the shares goes down. 484 00:44:46.540 --> 00:44:48.540 The managers also own shares. 485 00:44:48.540 --> 00:44:53.540 After all, managers get paid partly in shares of a corporation, especially with the income tax the way it is. 486 00:44:53.540 --> 00:44:56.540 They don't have to pay money on the shares of stock. 487 00:44:56.540 --> 00:45:03.540 So a top president of a corporation might make $200,000 in salary and $500,000 in shares of stock of a company. 488 00:45:03.540 --> 00:45:08.540 So he himself is a stockholder and is worried about, he doesn't like to see the value of the stock going down. 489 00:45:08.540 --> 00:45:14.540 So it works in a very quick, smooth fashion. You don't have to have the big dramatic vote. 490 00:45:14.540 --> 00:45:19.540 In contrast to that, of course, is government operations. 491 00:45:19.540 --> 00:45:24.540 We should always contrast and compare government with private enterprise. 492 00:45:24.540 --> 00:45:25.540 enterprise. 493 00:45:25.540 --> 00:45:32.140 A government firm, government agency, say the post office, the beloved postal service, or 494 00:45:32.140 --> 00:45:36.620 the transportation authority, we can't sell our shares in it, we're supposed to be owners. 495 00:45:36.620 --> 00:45:42.220 We the people are alleged owners of a public corporation, we're taxpayers and citizens 496 00:45:42.220 --> 00:45:43.220 therefore owners. 497 00:45:43.220 --> 00:45:46.420 We can't sell our share, if we don't like the profile and transit authority, if we don't 498 00:45:46.420 --> 00:45:49.500 like the way the rotten subway system is run, we can't sell our shares in it because we 499 00:45:49.500 --> 00:45:53.920 ain't got no shares, we can't sell our shares on a rotten postal office either. 500 00:45:53.920 --> 00:45:57.440 If we could do that, it would be a very different situation to keep the managers on their toes, 501 00:45:57.440 --> 00:46:01.720 but the managers get paid from the taxpayers, they don't care, there's no shareholders 502 00:46:01.720 --> 00:46:03.200 to worry about. 503 00:46:03.200 --> 00:46:07.080 So shareholders exert an enormous amount of power, even without voting, because voting 504 00:46:07.080 --> 00:46:10.000 is just a small part of it. 505 00:46:10.000 --> 00:46:14.240 By selling their shares, by the value of the shares going down, they register the signals 506 00:46:14.240 --> 00:46:18.400 of the managers, you better shape up, fella, because you're going to lose out. 507 00:46:18.400 --> 00:46:23.400 So selling shares of stock is very important. 508 00:46:23.400 --> 00:46:27.740 The market every day evaluates and re-evaluates corporations without fear or favor. They don't 509 00:46:27.740 --> 00:46:30.660 care about the fact that the guy's been a beloved and he's been a member of the Union 510 00:46:30.660 --> 00:46:35.720 League club, he's been a trench for 30 years. They don't care about that. If the prospects 511 00:46:35.720 --> 00:46:40.720 are bad, they start selling their share and the stock's value goes down. 512 00:46:40.720 --> 00:46:47.600 Also, of course, in addition to selling the stock, which is the key thing, keeping managers 513 00:46:47.600 --> 00:46:54.200 is honest, is the so-called takeover bid, as you see very dramatically, if the share 514 00:46:54.200 --> 00:47:00.240 of stock gets low, in other words, if it's basically sound corporation but being badly 515 00:47:00.240 --> 00:47:06.000 managed and the value of the share goes way down, this becomes a tempting for takeover 516 00:47:06.000 --> 00:47:10.840 bids for other capitalists to say, look, the right letters to the shareholders, say, look, 517 00:47:10.840 --> 00:47:14.960 get us in there, we'll take this company, we'll make a big profit out of it, and we 518 00:47:14.960 --> 00:47:21.660 To improve our judgment and our capacity for making profits by giving you a much bigger 519 00:47:21.660 --> 00:47:24.840 deal than you're getting, better deal than you're getting now, let's say the value of 520 00:47:24.840 --> 00:47:29.880 a share of a corporation is $70 a share, we'll pay you $100 a share if you get us in, if 521 00:47:29.880 --> 00:47:31.960 you sell us enough shares so we can take over. 522 00:47:31.960 --> 00:47:36.080 This is a powerful incentive, it's also a powerful incentive for the existing managers 523 00:47:36.080 --> 00:47:40.240 to shape up and not let the corporation run down and not make profits, otherwise somebody 524 00:47:40.240 --> 00:47:42.360 will come in and take over a bid. 525 00:47:42.360 --> 00:47:50.360 Interestingly enough, the liberal media, the establishment, so to speak, is always in favor of the managers. 526 00:47:50.360 --> 00:47:54.360 Next time you notice about a takeover, they always hate the takeover bidder. 527 00:47:54.360 --> 00:47:57.360 The takeover bidder is a corporate raider, he's a pirate. 528 00:47:57.360 --> 00:48:00.360 He comes from Texas, which automatically makes him evil. 529 00:48:00.360 --> 00:48:04.360 He's despising these beloved managers who have been here for 30 years. 530 00:48:04.360 --> 00:48:07.360 Well, that's the whole point of capitalism and the market economy. 531 00:48:07.360 --> 00:48:09.360 You're being despised if you're doing a lousy job. 532 00:48:09.360 --> 00:48:13.560 and job. And so this is what competition is all about. It's interesting that liberals 533 00:48:13.560 --> 00:48:18.880 who tend to be, who propound of the idea that a terrible thing managers are taking over from 534 00:48:18.880 --> 00:48:22.480 stockholders, when it gets down to the bone and the stockholders revolt, they're always 535 00:48:22.480 --> 00:48:26.920 in favor of the managers against the stockholders. It's an interesting little item here. Any 536 00:48:26.920 --> 00:48:33.320 change in the status quo they consider somehow disrupting and bad in some sense. Of course 537 00:48:33.320 --> 00:48:37.200 the managers are there telling the, they are there as the existing managers, the president 538 00:48:37.200 --> 00:48:43.600 and whatever corporation is being under a quote, attack unquote from a takeover bid is giving 539 00:48:43.600 --> 00:48:47.320 interviews to the New York Times or the Post or whatever it is and CBS and saying, look 540 00:48:47.320 --> 00:48:50.800 at the terrible thing, these guys are from Texas and they're evil. Guys from Texas aren't 541 00:48:50.800 --> 00:48:55.360 here and established and therefore they don't have the access to the media that the local 542 00:48:55.360 --> 00:49:02.000 people do. So there's always a poisoned atmosphere against the newcomers, reinforced often by 543 00:49:02.000 --> 00:49:05.760 court decision. Of course the lawyers are in there all the time. Every one of these 544 00:49:05.760 --> 00:49:14.760 These guys are fleets of corporate lawyers battling in the courts for years to try to stop takeover bids, to try to facilitate them. 545 00:49:14.760 --> 00:49:21.760 But anyway, the takeover bid has been a powerful weapon in keeping the managers on their toes and kicking them out if they don't do a lousy job. 546 00:49:21.760 --> 00:49:24.760 You don't have to wait for the stockholders themselves to organize and get together. 547 00:49:24.760 --> 00:49:29.760 The takeover bidder, T-Bone Pickens or whoever it is, comes in and says, okay, I'm going to buy Carl Icahn, one of these guys. 548 00:49:29.760 --> 00:49:33.760 They come in and say, okay, we're going to buy this corporation if we think it's doing a lousy job. 549 00:49:33.760 --> 00:49:39.360 and we'll do a lot better. We'll pay the shareholder $30 on a share, which is a powerful incentive. 550 00:49:39.360 --> 00:49:45.440 So anyway, through this, through these methods, to take over a business, especially through 551 00:49:45.440 --> 00:49:52.360 selling stock, stockholders are effectively the directors or owners of the corporation, 552 00:49:52.360 --> 00:49:57.280 not the managers, although the managers get the publicity, of course, on a day-to-day 553 00:49:57.280 --> 00:50:01.000 basis. Of course, if I own one share of General Motors, I'm not going to have much of a say 554 00:50:01.000 --> 00:50:06.760 I'm not saying each individual is stock hold, except to selling stock as a share, as a 555 00:50:06.760 --> 00:50:07.760 power. 556 00:50:07.760 --> 00:50:11.960 So if you have, let's say, 10% of the stock, or a group of people have 10 or 15%, you can 557 00:50:11.960 --> 00:50:13.600 basically run it. 558 00:50:13.600 --> 00:50:17.880 And of course, if the manager does a lousy job, you might not want to run it anymore. 559 00:50:17.880 --> 00:50:21.760 You might want to sell it to somebody else who comes over to take over a bit. 560 00:50:21.760 --> 00:50:29.000 So in this way, the stock market works in such a way as to make the market economy as 561 00:50:29.000 --> 00:50:30.000 efficient as possible. 562 00:50:30.000 --> 00:50:36.760 is profitable and is efficient in serving the consumers as humanly possible, making a manager 563 00:50:36.760 --> 00:50:37.760 shape up. 564 00:50:37.760 --> 00:50:41.920 It's true that managers do try to finagle from time to time. 565 00:50:41.920 --> 00:50:53.280 For example, when you're estimating your profits, during inflation, let's say you have a million 566 00:50:53.280 --> 00:50:59.200 dollar machine, you spent a million dollars on it, say 1980, and let's say it's a ten-year 567 00:50:59.200 --> 00:51:06.000 Fair Machines, 1990 is going to have to be replaced, Orthodox Accounting Methods, I think 568 00:51:06.000 --> 00:51:11.160 I've referred to this in the past here, there's a constant war between accountants and economists, 569 00:51:11.160 --> 00:51:15.400 it's been going on for about 40 years since the modern age of inflation has come down 570 00:51:15.400 --> 00:51:19.200 under the way, if you buy a machine for a million dollars, you're supposed to evaluate 571 00:51:19.200 --> 00:51:24.240 it on the books at a million dollars, it's called historical cost accounting, and then 572 00:51:24.240 --> 00:51:29.920 Even if, in other words, this is what you actually pay for, you paid a million bucks, 573 00:51:29.920 --> 00:51:34.480 and then ten years later, if you have to replace it, you depreciate, say, 100,000 a year, so 574 00:51:34.480 --> 00:51:37.480 you have a fund of a million dollars to buy another one. 575 00:51:37.480 --> 00:51:42.920 So this is all very well if there's no inflation, but if you have a chronic inflation as we've 576 00:51:42.920 --> 00:51:47.680 had now since World War II, this is not going to work, this distorts the actual picture 577 00:51:47.680 --> 00:51:53.520 of a corporate firm, because let's say prices have doubled in these ten years, which is 578 00:51:53.520 --> 00:52:01.520 This is not unusual. Prices in fact have gone up eightfold since 1940, threefold since tripled since 1967, tripled in the last 20 years. 579 00:52:01.520 --> 00:52:08.520 So if they double in these 10 years, you take your million bucks in 1990 to replace the machine, you find you can only buy half of it. 580 00:52:08.520 --> 00:52:15.520 You need another million to replace it. So that the replacement cost, which is really the important thing, who cares about the historical cost? 581 00:52:15.520 --> 00:52:22.520 It's interesting for historians. If it now costs two million dollars because of inflation, it means you're wiping out your capital. 582 00:52:22.520 --> 00:52:25.880 capital. In other words, you think you may have big profits which you really haven't. 583 00:52:25.880 --> 00:52:31.400 In other words, let's say if you think your profit is five million dollars this year, 584 00:52:31.400 --> 00:52:34.800 but it's only because you have to replace a couple of machines and you're reckoning 585 00:52:34.800 --> 00:52:38.040 it as a million, but it's really cost too many, it really made very little profits. 586 00:52:38.040 --> 00:52:42.460 In other words, there's this profit, you over inflate, you inflate how much profit you make 587 00:52:42.460 --> 00:52:47.820 because you don't take into account the increase in capital costs, increase in the cost of 588 00:52:47.820 --> 00:52:50.700 and the replacement of machinery. 589 00:52:50.700 --> 00:52:54.300 So ever since inflation started after World War II, economists have been telling accounts, 590 00:52:54.300 --> 00:52:58.380 look, this is great if you don't have inflation, it's distorting the whole picture. 591 00:52:58.380 --> 00:53:02.380 Accountants are finally beginning to come around after about 40 years to realizing they've 592 00:53:02.380 --> 00:53:03.740 got to do something. 593 00:53:03.740 --> 00:53:06.100 That's true, it gets sloppy, you see. 594 00:53:06.100 --> 00:53:08.900 If you base it as a million, if you paid a million bucks for it, you have a check in 595 00:53:08.900 --> 00:53:13.660 1980 saying, okay, I paid a million dollars for this, this is objective, that's precise. 596 00:53:13.660 --> 00:53:17.180 If you're trying to estimate how much inflation is, it's not objective, it's not precise, 597 00:53:17.180 --> 00:53:22.180 Tax, as we see in macro courses, it's very imprecise, but still you have to do something 598 00:53:22.180 --> 00:53:24.700 because otherwise you're going to be wiped out, your capital investments are going to 599 00:53:24.700 --> 00:53:25.700 be wiped out. 600 00:53:25.700 --> 00:53:29.860 So as a result, what happens is over the years there's been a connivance between of course 601 00:53:29.860 --> 00:53:35.380 accountants who've been largely in the 19th century accounting methods, pre-inflationary 602 00:53:35.380 --> 00:53:40.260 accounting methods, the government, the IRS, which always wants to have tax more, if you 603 00:53:40.260 --> 00:53:43.220 think there's higher profits it means the government can tax it away, and managers who 604 00:53:43.220 --> 00:53:47.640 Managers like to fool their stockholders into thinking their profits are high. 605 00:53:47.640 --> 00:53:50.700 Managers don't like to tell their stockholders, it looks like their high profits has really 606 00:53:50.700 --> 00:53:51.980 been eaten away by inflation. 607 00:53:51.980 --> 00:53:58.740 It's been sort of a conspiracy for many years of accountants, top managers in the government, 608 00:53:58.740 --> 00:54:04.540 each one trying to bolster the old accounting system. 609 00:54:04.540 --> 00:54:07.780 But as I say, after about 30 or 40 years, finally it's begun to sunk in. 610 00:54:07.780 --> 00:54:11.980 It's more or less shifting now toward a more rational accounting system. 611 00:54:11.980 --> 00:54:25.980 Anyway, this is one of the pitfalls here, and it's some ways in which at least in the short run, top managers try to fool the stockholders, it doesn't work forever, at least it's sort of a short run advantage. 612 00:54:25.980 --> 00:54:28.980 Of course, Brilliant Means didn't talk about that. 613 00:54:28.980 --> 00:54:37.980 The places, again, where the managers really take over is across the government, there's almost no check at all. 614 00:54:37.980 --> 00:54:48.980 You can't sell your share in the post office, and therefore the taxpayer gets sucked in and doesn't know what's going on, and the government managers, government bureaucrats can then go ride high-wide and handsome. 615 00:54:48.980 --> 00:54:58.980 There's also another, there's a famous attack on the idea of maximizing profits, the so-called questionnaire method. 616 00:54:58.980 --> 00:55:05.980 These are sociologists who go around the businessman, they go to say the president and the chairman of the board are saying 617 00:55:05.980 --> 00:55:11.280 Is it your goal, Sarah, to maximize profits? Of course they're going to say no, I mean, it sounds terrible. 618 00:55:11.280 --> 00:55:19.980 No, no, my goal is not to maximize profits, my goal is to help the world and the country and God and all that sort of stuff, and we'd like to stay in business to be able to do that, okay? 619 00:55:19.980 --> 00:55:25.980 So this is not the way you go, and then they conclude from this, the sociologists, and therefore business is not in favor of maximizing their profits. 620 00:55:25.980 --> 00:55:35.880 This is not the sort of question you ask, because Paul Samuelson, I'm not a great friend of Paul Samuelson, but in his textbook on economics, he did, I think, an effective two-paragraph smash of this. 621 00:55:35.880 --> 00:55:39.320 What he said was, look, what you ask a businessman is this, you don't ask him, are you in favor 622 00:55:39.320 --> 00:55:40.320 of maximizing your profits? 623 00:55:40.320 --> 00:55:46.360 You say, Sarah, looking back on your decisions that you made last year, all your business 624 00:55:46.360 --> 00:55:50.520 decisions, is there any one decision where you deliberately avoided making profits, where 625 00:55:50.520 --> 00:55:52.520 you said, no, I'll take a cut in profits? 626 00:55:52.520 --> 00:55:54.520 A businessman always says, why should I do that? 627 00:55:54.520 --> 00:55:56.000 Why should I do a crazy thing like that? 628 00:55:56.000 --> 00:55:57.000 Of course not. 629 00:55:57.000 --> 00:56:00.320 In other words, you take the marginal approach, you break it down into marginal units. 630 00:56:00.320 --> 00:56:06.280 In each of these 50 decisions that you've made, in each one you try to increase your 631 00:56:06.280 --> 00:56:09.720 profit as much as you could on that, make as much profit as you could and not try to 632 00:56:09.720 --> 00:56:10.720 cut your profit. 633 00:56:10.720 --> 00:56:15.240 And then, of course, conceding the fact that your goal is to maximize profits. 634 00:56:15.240 --> 00:56:20.760 So it depends on the way you put it, you put it in the sense of looking at each decision, 635 00:56:20.760 --> 00:56:21.760 what did you do? 636 00:56:21.760 --> 00:56:25.200 And you get a rational answer, of course, that's basically it, you don't get a guff 637 00:56:25.200 --> 00:56:30.020 about the public welfare in your country and stuff like that. 638 00:56:30.020 --> 00:56:33.780 So in any rate, the goal of each physics firm is to increase your profits as much as you 639 00:56:33.780 --> 00:56:45.780 can and to avoid losses. Total revenue, first of all we start, oh I should say, I was going 640 00:56:45.780 --> 00:56:51.100 to bring in the readings, read the stuff, does anybody have the book here, Miller book, 641 00:56:51.100 --> 00:56:56.820 the next set of readings I think I have it on the syllabus, if anybody has seen the syllabus, 642 00:56:56.820 --> 00:57:04.140 It's the, I think chapter 9, I'll tell you next time, I have it in my briefcase, it's 643 00:57:04.140 --> 00:57:11.620 the chapter I'm, oh, ah, thank you, great, it's, yeah, this is chapter, this is part 644 00:57:11.620 --> 00:57:21.220 3, chapters 4, 9, 10, 12 and 14, it gets to the, well, at this point, up until this point 645 00:57:21.220 --> 00:57:25.500 I've been more or less agreeing with the book, except I don't have a lot of stuff the book 646 00:57:25.500 --> 00:57:31.220 from now on it gets to be much more divergent, although Miller is better than most other 647 00:57:31.220 --> 00:57:37.180 books on this topic. People who write textbooks are mired in tradition, they have to present 648 00:57:37.180 --> 00:57:42.140 a certain apparatus even though they don't agree with it, at least they feel they do. 649 00:57:42.140 --> 00:57:51.140 So I'm going to take a much shorter and more common sense of view of this whole situation. 650 00:57:51.140 --> 00:58:01.140 So, this is important for you because you don't have to worry about two-thirds to nine-tenths of the material, you know, because I'm not going to talk about it, and if I don't talk about it, it's not going to be on a test. 651 00:58:03.140 --> 00:58:19.140 You start with the basic diagram here, on the y-axis, a set of price and y-axis is dollars, which is sort of like price, except now it's just total dollars, x-axis, quantity of goods, the usual quantity, the x-axis. 652 00:58:19.140 --> 00:58:23.140 If you're a business firm, you're making a certain product, whatever it is. 653 00:58:23.140 --> 00:58:27.140 If you don't sell anything, you're not going to get anything, you're not going to get any income. 654 00:58:27.140 --> 00:58:31.140 So you start with zip, start at the point of origin. 655 00:58:31.140 --> 00:58:35.140 If I sell zero steel bars, I get zero revenue from it. 656 00:58:39.140 --> 00:58:45.140 The total revenue, as we've seen up until now in the course, 657 00:58:45.140 --> 00:59:01.140 Of course, it's price times quantity, and this of course is the demand curve, that's also the price on the y-axis, and whatever it is in the quantity x-axis, whatever the slope is. 658 00:59:01.140 --> 00:59:11.140 So we know that total revenue is the area, and it depends on the elasticity of the demand curve, which can be whatever it is, can be anything, as long as it's falling. 659 00:59:11.140 --> 00:59:16.740 Well, if you have, if the price is full, here's quantity and price. These are two basic diagrams. 660 00:59:16.740 --> 00:59:21.380 The old diagram we're familiar with, price on the y-axis, quantity on the x-axis. And 661 00:59:21.380 --> 00:59:25.460 this is the new one, dollars on the y-axis and quantity on the x-axis. Here's a business 662 00:59:25.460 --> 00:59:30.580 firm that's making whatever it is, widgets. If it makes a certain amount, it sells at 663 00:59:30.580 --> 00:59:36.080 a certain price, and this is the point here. If it lowers the price and increases the quantity 664 00:59:36.080 --> 00:59:42.960 Here, total revenue will change, whatever it is. If it's elastic, in other words, if 665 00:59:42.960 --> 00:59:53.200 the total revenue goes up as the price falls, this is fairly flat, then we depict it on 666 00:59:53.200 --> 00:59:57.640 this diagram, quantity increases from here to here, total revenue goes up. Obviously, 667 00:59:57.640 --> 01:00:03.600 it has to go up from zero anyway, right? It can't get lower than zero. So total revenue, 668 01:00:03.600 --> 01:00:10.000 We start with a rising total revenue curve, this is TR, as quantity increases, it keeps 669 01:00:10.000 --> 01:00:14.640 going up to a certain extent, whatever, it finally gets to the point, let's say, as quantity 670 01:00:14.640 --> 01:00:25.640 increases where total revenue falls, it becomes inelastic at a certain zone, and when that 671 01:00:25.640 --> 01:00:33.000 happens, you have a dip, in other words, it reaches a peak, total revenue now falls. 672 01:00:33.000 --> 01:00:37.280 This part of the curve is the elastic demand curve zone, by definition. In other words, 673 01:00:37.280 --> 01:00:42.280 when the quantity increases, price goes up, and total revenue increases, that means it's 674 01:00:42.280 --> 01:00:46.320 the elastic. When the total revenue declines when the price, when the quantity goes up 675 01:00:46.320 --> 01:00:51.080 and the price falls, it means it's inelastic. This is the inelastic zone. Now the textbooks 676 01:00:51.080 --> 01:00:55.720 all have, this is their curve. They have a one peak curve. It doesn't have to be one 677 01:00:55.720 --> 01:00:59.640 peak. God is not, not the creed has to be one peak. It's not going up again. It could 678 01:00:59.640 --> 01:01:10.640 I prefer this kind of a curve because it shows that there's no reason why it has to be one peak except convenience of the guy who draws the diagram. 679 01:01:10.640 --> 01:01:17.640 In this case, this would be elastic again, and this would be inelastic after this. 680 01:01:17.640 --> 01:01:25.640 So if an n-peak total revenue curve, in this case it's two, I admit that it's more convenient to have one peak, 681 01:01:25.640 --> 01:01:32.640 The total cost is, Professor Hoppe mentioned to you in the last lecture, again in the diagram which you have in the textbook, you have dollars on the y-axis, quantity on the x-axis, quantity of goods, you have a total cost curve, in the first place, the total cost curve looks like this, 682 01:01:55.640 --> 01:02:10.640 It's not really, it doesn't have to be like that. God is not the creed, it has to be like that. It could be almost anything. In other words, it could be higher, it could be lower. If you want to increase costs, if you're paid to increase costs, you'll do it. 683 01:02:10.640 --> 01:02:20.640 It's very easy. Businessmen love to have the government tell them, say, increase your costs and we will recompense you for it. It's essentially the cost plus defense contract kind of system. 684 01:02:20.640 --> 01:02:27.280 The firms love defense contracts because they can get a guaranteed profit of the cost plus 685 01:02:27.280 --> 01:02:28.280 rate. 686 01:02:28.280 --> 01:02:32.720 In other words, government tells you, look, whatever your costs are, we will pay you back 687 01:02:32.720 --> 01:02:34.600 plus 8% profit or whatever it is. 688 01:02:34.600 --> 01:02:39.760 It's not the percentage that counts, it's the fact that the cost of profit is guaranteed. 689 01:02:39.760 --> 01:02:45.160 So if the cost, if the government will reimburse everybody's costs, what the hell, let it rip. 690 01:02:45.160 --> 01:02:50.440 Have beautiful offices, it's very easy to increase costs, it's a pleasure, it's tough 691 01:02:50.440 --> 01:02:54.840 You have to cut costs, it's very difficult. You start paying high salaries, you hire a 692 01:02:54.840 --> 01:02:59.720 lot of engineers. You notice, for example, that the defense contract advertisers for engineers 693 01:02:59.720 --> 01:03:05.080 are much bigger than non-defense firms because their advertising costs are repaid by the 694 01:03:05.080 --> 01:03:08.240 government. What the hell? The government pays your advertising costs for engineers. 695 01:03:08.240 --> 01:03:11.680 Letter gets full-page ads on the Wall Street Journal, New York Times. Engineers come to 696 01:03:11.680 --> 01:03:17.720 glorious California, okay? If you're a private firm which has to make it on the free market, 697 01:03:17.720 --> 01:03:20.720 and you can't afford to do that, you have to be more modest. 698 01:03:20.720 --> 01:03:28.720 So if you can convince the government that these are reasonable costs, in other words, you need engineers, it's certainly reasonable to have ads, then you can let her rip. 699 01:03:28.720 --> 01:03:34.720 Of course, what's reasonable is very elastic, it depends on whether you're the buddy of the guy in the fence department. 700 01:03:34.720 --> 01:03:41.720 Usually you are, and so the whole thing is very cozy and the costs tend to escalate like that. 701 01:03:41.720 --> 01:03:46.720 That's why you have the $6,000 coffee machines and sort of stuff. 702 01:03:46.720 --> 01:03:55.720 because there's no market test, there's no market test saying you're going to lose defense contracts, defense firms will go out of business or the pentagon will go out of business if they lose money. 703 01:03:55.720 --> 01:04:02.720 Uncle Sapp, the taxpayer, that's us, pays the bill, therefore it goes skyrocketing. 704 01:04:02.720 --> 01:04:08.720 This cost curve in the textbook is only when the firm is trying desperately to cut costs, it was to avoid losses. 705 01:04:08.720 --> 01:04:15.720 It was to keep the total cost at a minimum, as low as possible, so that they'll make profits. 706 01:04:15.720 --> 01:04:22.720 So this cost curve is the envelope, the minimum envelope of an array of possible costs. 707 01:04:22.720 --> 01:04:26.720 In other words, it's the lowest cost in any given quantity produced. 708 01:04:26.720 --> 01:04:31.720 And the reason why business firms will operate at the lowest cost is because of their economic interest to do so, 709 01:04:31.720 --> 01:04:37.720 to try and make profits and avoid losses. They will try their damnedest to keep their costs as low as possible for any given output. 710 01:04:37.720 --> 01:04:44.720 That's why you have the cost curve. If you didn't have the free market incentive to avoid losses and make profits, the cost can be anyplace. 711 01:04:44.720 --> 01:04:53.680 skyrocket, $5,000 coffee machines and $20 nails and that sort of, it can be almost anything. 712 01:04:53.680 --> 01:05:02.920 So that's one thing, we have a minimum, it's a minimum envelope of possible costs. 713 01:05:02.920 --> 01:05:07.180 The other thing is, the next point of dispute here is, my contention is if you don't make 714 01:05:07.180 --> 01:05:12.600 any widgets, I'm not a widget manufacturer, I make zero widgets per year, zero steel bars, 715 01:05:12.600 --> 01:05:18.600 0 stereo set, therefore my costs are 0, and this is saying it's fixed cost, it's all baloney, 716 01:05:18.600 --> 01:05:24.680 in other words, you start again at the point of origin, 0 quantity, 0 cost, and it's true 717 01:05:24.680 --> 01:05:31.680 that there are different kinds of indivisibility that we'll get into later in costs, you build 718 01:05:32.120 --> 01:05:36.040 a plant, you have a fixed cost of operation, you don't produce any widgets, but you don't 719 01:05:36.040 --> 01:05:40.880 have to have a plant, you can sell a man plant, you can get out, you can shut it down, you 720 01:05:40.880 --> 01:05:44.000 They don't have to have fixed costs, there's no such thing as fixed costs, they're all 721 01:05:44.000 --> 01:05:46.600 different degrees of variability. 722 01:05:46.600 --> 01:05:50.280 So you can toss out all this fixed variable stuff, which unfortunately is of the harder, 723 01:05:50.280 --> 01:05:54.920 much microeconomic textbooks, and what you've got really is this, you have total costs which 724 01:05:54.920 --> 01:06:00.360 start at a total cost curve, the minimum and lowest envelope of possible costs, any given 725 01:06:00.360 --> 01:06:08.360 quantity, and start at the point of origin, total cost zip. 726 01:06:08.360 --> 01:06:13.360 And my contention is, which I now have to prove, is that total costs always go up. 727 01:06:13.360 --> 01:06:22.360 In other words, that total costs always increase as quantity increases. 728 01:06:22.360 --> 01:06:24.360 So this is not self-evident. 729 01:06:24.360 --> 01:06:28.360 As a matter of fact, many people think, well, gee, it's not true. 730 01:06:28.360 --> 01:06:31.360 Aren't there costs of large-scale production? 731 01:06:31.360 --> 01:06:33.360 Don't the cost curve go down? 732 01:06:33.360 --> 01:06:34.360 Not total costs, however. 733 01:06:34.360 --> 01:06:36.360 Average costs go down, as we'll see. 734 01:06:36.360 --> 01:06:37.360 Total costs keep going up. 735 01:06:37.360 --> 01:06:42.520 going up. And this can be proven logically. In other words, while total revenue can either 736 01:06:42.520 --> 01:06:45.440 go up or down, depending on, because there are two forces at work, remember with total 737 01:06:45.440 --> 01:06:48.840 revenue, there's prices and there's quantity, each going in different directions. Price 738 01:06:48.840 --> 01:06:52.600 goes down, quantity goes up. And there's a tug of war to see what happens with total 739 01:06:52.600 --> 01:06:55.920 revenue. It can either go up or down. Total costs are, on the other hand, always going 740 01:06:55.920 --> 01:07:02.120 up. Let's prove it by reductio ad absurdum. That's the easiest way to demonstrate this. 741 01:07:02.120 --> 01:07:07.120 In other words, to show that anything else is illogical and absurd. 742 01:07:07.120 --> 01:07:14.120 Let's take, this is quantity produced total cost. 743 01:07:14.120 --> 01:07:24.120 Let's say you have a business firm producing a hundred cases, a hundred widgets, a hundred steel bars, wherever the unit happens to be. 744 01:07:24.120 --> 01:07:29.120 Let's assume it's minimum total cost. Remember, this is minimum, the lowest envelope. 745 01:07:29.120 --> 01:07:35.120 The minimum total cost is, I don't know, $5,000. It doesn't matter what it is. 746 01:07:36.120 --> 01:07:40.120 Now the firm makes another unit and increases its quantity to say 101. 747 01:07:42.120 --> 01:07:48.120 What I'm saying is it's illogical and absurd to say that the total cost goes down to say 4,500. It's impossible. 748 01:07:48.120 --> 01:07:51.120 It's largely impossible for this reason. 749 01:07:52.120 --> 01:07:57.120 If your minimum total cost is $5,000 for making 100, 750 01:07:57.120 --> 01:08:22.120 and you make a hundred and one, you have to produce, to say that the total cost goes down, means you can, you can take the 45, you can, let's put it this way, 751 01:08:22.120 --> 01:08:27.040 But, if you say that, look, I'm saying this is impossible for this reason, demonstrated this way. 752 01:08:27.040 --> 01:08:34.680 If this is, if the minimum total cost for producing 101 is 4500, it means you can take, you can produce the 101 for 4500, you can throw away one, 753 01:08:34.680 --> 01:08:41.320 and you're left then with, but this is 4500 and not a 5000, the initial conditions of the problem are impossible. 754 01:08:41.320 --> 01:08:47.160 See what I mean? In other words, it's impossible to say that if you increase the production that you lower the total cost, 755 01:08:47.160 --> 01:08:57.840 because then you can take the lower total cost, throw one away, throw the extra one away and you'll left them with $4,500, you can't, the initial conditions of the problem are then violated 756 01:08:57.840 --> 01:09:02.000 so, and you can't even have it the same 757 01:09:02.000 --> 01:09:15.160 because one more costs something, even if it's a little bit, even if the material on one widget will cost a few cents, you know, it can't even be the same, you can take that and you can throw that away 758 01:09:15.160 --> 01:09:16.600 so therefore 759 01:09:16.600 --> 01:09:19.440 the amount, the total cost always have to go up 760 01:09:19.440 --> 01:09:22.800 in other words, remember this is the minimum total cost 761 01:09:22.800 --> 01:09:26.560 the minimum can't be five thousand, and this can't be less than, because 762 01:09:26.560 --> 01:09:28.280 as I said, if you can't 763 01:09:28.280 --> 01:09:30.940 you can then produce the hundred and one 764 01:09:30.940 --> 01:09:35.680 pocket the one, and then you have, this will be forty five hundred and not five thousand 765 01:09:35.680 --> 01:09:37.360 this is an illogical 766 01:09:37.360 --> 01:09:40.640 illogical situation, violates the conditions of the problem 767 01:09:40.640 --> 01:09:44.320 so therefore total costs always have to go up, even if by a little bit 768 01:09:44.320 --> 01:09:50.320 The economies of large-scale production do not apply to total cost, they apply to average total cost, which is very different. 769 01:09:50.320 --> 01:09:57.320 It's total cost per unit that goes down for large-scale production, not total cost period. 770 01:09:57.320 --> 01:10:03.320 So this always is going up from the point of origin, which is zero, on up. 771 01:10:03.320 --> 01:10:07.320 So then the business firm has got to pick the maximum profit point. 772 01:10:07.320 --> 01:10:13.320 The maximum profit point will be the largest distance between total revenue and total cost. 773 01:10:13.320 --> 01:10:28.320 Say that, or this, and the conditions for it, and this is what gets in all the average and marginal stuff that the textbooks are filled with 774 01:10:28.320 --> 01:10:34.320 The conditions for say, take this as the maximum distance between total revenue and total costs 775 01:10:34.320 --> 01:10:40.320 Those of you who have taken differential calculus will immediately begin to see the analogies here 776 01:10:40.320 --> 01:10:44.320 At this point, there's a maximum difference between these two. 777 01:10:44.320 --> 01:10:52.320 The slope of the, tangent of the slope, yeah, tangent of the slope will be equal. 778 01:10:52.320 --> 01:11:00.320 The total cost curve and the total revenue curve will be the same at maximum distance. 779 01:11:00.320 --> 01:11:16.320 This is the tangent, delta change in TR divided by delta Q, and this is change in TC divided by delta Q. 780 01:11:16.320 --> 01:11:23.320 This is also known as marginal revenue, the change in total revenue, whether increase or decrease. 781 01:11:23.320 --> 01:11:28.320 With one more unit of quantity, there's the marginal revenue and the change in total cost, 782 01:11:28.320 --> 01:11:35.160 There's always going up, remember, one more unit of cost, marginal cost, where these two 783 01:11:35.160 --> 01:11:38.000 things are the slope of the same, the marginal revenue and marginal cost are equal. 784 01:11:38.000 --> 01:11:42.720 This is the famous marginal revenue and marginal cost criterion. 785 01:11:42.720 --> 01:11:46.160 All it's really saying is, it's not saying anything else than the total revenue, the 786 01:11:46.160 --> 01:11:47.640 total profits are maximized. 787 01:11:47.640 --> 01:12:03.640 In other words, with this kind of curves, this is maximized when, this is profits, this is maximized when marginal revenue is equal to marginal cost. 788 01:12:03.640 --> 01:12:09.640 MR is delta TR over delta Q, MC is delta TC over delta Q. 789 01:12:09.640 --> 01:12:13.640 The way you have, when the change is infinitely, this is where differential calculus comes in, 790 01:12:13.640 --> 01:12:19.640 when the change is infinitely small, infinitesimally small, then this becomes first derivative, 791 01:12:19.640 --> 01:12:22.640 DTR versus over DQ, etc. 792 01:12:22.640 --> 01:12:26.640 Unfortunately, in human action, you don't have infinitesimally small steps. 793 01:12:26.640 --> 01:12:30.640 Therefore, calculus is really illegitimate in this situation. 794 01:12:30.640 --> 01:12:34.640 However, this is my gripe with mathematical economics in general. 795 01:12:34.640 --> 01:12:36.640 But this is where this thing comes from. 796 01:12:36.640 --> 01:12:46.640 Taking infinitely small steps, you will get, then, this first derivative, delta dT or marginal revenue is equal to marginal cost. 797 01:12:46.640 --> 01:12:52.640 But you're not saying anything more, notice. You're not saying anything more of interest than simply you're trying to maximize profit. 798 01:12:52.640 --> 01:12:56.640 This is a criterion for maximizing profit. That's all there is to it. This is a whole shtick. 799 01:12:56.640 --> 01:13:01.640 Millions of words are wasted and economics works on this whole topic. 800 01:13:01.640 --> 01:13:05.540 another problem with this is once you realize there might be more than one peak 801 01:13:05.540 --> 01:13:08.260 this could also be a minimum 802 01:13:08.260 --> 01:13:12.180 this could also identify a minimum profit point 803 01:13:12.180 --> 01:13:16.420 or it could be another maximum, so which is better? you can only find out which is better 804 01:13:16.420 --> 01:13:19.220 which is minimum, which is maximum by inspecting the total 805 01:13:19.220 --> 01:13:21.260 you're back on the total again, minimum 806 01:13:21.260 --> 01:13:24.600 so the marginal stuff really misleads you more than anything else 807 01:13:24.600 --> 01:13:27.540 so it's an interesting way of looking at it 808 01:13:27.540 --> 01:13:30.380 in many ways helpful to show what's going on 809 01:13:30.380 --> 01:13:41.380 You're interested in each step of the way of making a profit, that your marginal revenue is at least greater or at least no less than the marginal cost for any decision, economic or business decision. 810 01:13:41.380 --> 01:13:46.380 You want to make sure you're taking in at least as much as you're paying out, hopefully, of course, more. 811 01:13:46.380 --> 01:13:51.380 But the main point is that the total is really the key. The key is you're trying to make total profits. 812 01:13:51.380 --> 01:13:55.380 The rest of the stuff, you can see how the mathematical economists get wrapped up in this. 813 01:13:55.380 --> 01:13:58.980 You get fascinated by the tangencies, by slopes, and all that sort of stuff, but it's really 814 01:13:58.980 --> 01:14:02.020 all subordinate to the main problem. 815 01:14:02.020 --> 01:14:04.660 Business man cares about profits and losses, he doesn't really care about the other stuff, 816 01:14:04.660 --> 01:14:08.340 and this is why when economists talk to business men, it's all breakdown of communication. 817 01:14:08.340 --> 01:14:09.340 What do you mean by marginal? 818 01:14:09.340 --> 01:14:13.060 They don't understand what marginal cost is, marginal, and for good reason. 819 01:14:13.060 --> 01:14:18.780 Most of it is a lot of periphery, frippery, I would say, useless frippery on the main 820 01:14:18.780 --> 01:14:19.780 topic. 821 01:14:19.780 --> 01:14:24.180 At any rate, so if you have more than, especially as I say, if you have more than one peak, 822 01:14:24.180 --> 01:14:29.180 If you think you can get into big trouble by only talking about marginal, because it could easily be a minimal profit. 823 01:14:29.180 --> 01:14:33.180 It's the only way to make sure by looking at the actual totals. 824 01:14:33.180 --> 01:14:38.180 So the whole point here is to say maximize total revenue minus total cost, 825 01:14:38.180 --> 01:14:47.180 and the equality of marginal revenue and marginal cost is an interesting property of a maximum profit situation. 826 01:14:47.180 --> 01:15:02.180 This gives us our marginal revenue and marginal cost. Marginal revenue is delta tc over delta q. 827 01:15:02.180 --> 01:15:07.180 When delta q is 1, of course, it becomes very easy to look, you know, just delta tr. 828 01:15:07.180 --> 01:15:11.180 And marginal cost is delta tc over delta q. 829 01:15:11.180 --> 01:15:23.300 The other thing, the average comes in, again it's fairly simple now, the average revenue 830 01:15:23.300 --> 01:15:30.420 is TR over Q. That's the average revenue per unit, average revenue per unit produced. That's 831 01:15:30.420 --> 01:15:39.100 the same thing as price. In other words, if you're selling five cases of widgets at $5,000, 832 01:15:39.100 --> 01:15:41.600 You're selling $1,000 per case. That's what price is. 833 01:15:41.600 --> 01:15:44.100 This is our demand curve, in other words. 834 01:15:44.100 --> 01:15:47.100 Same thing, remember P times Q is equal to TR. 835 01:15:47.100 --> 01:15:50.100 So average revenue is the same thing as price. 836 01:15:50.100 --> 01:15:53.100 That's where it all fits in. This is why you have these two curves. 837 01:15:53.100 --> 01:15:59.100 The total revenue curve here, and the average revenue curve, which is the demand curve. 838 01:15:59.100 --> 01:16:01.100 Price and quantity. 839 01:16:01.100 --> 01:16:06.100 Average cost is total cost divided by quantity. 840 01:16:06.100 --> 01:16:13.100 This is average total cost, I should say, because I don't talk about average fixed cost, average variable, it's all nonsense. 841 01:16:13.100 --> 01:16:23.100 The average total cost is the total cost divided by quantity. In other words, if you spend a million dollars and produce 100 units or something, the cost is $100,000 per unit. 842 01:16:23.100 --> 01:16:27.100 $10,000 per unit. In other words, you divide the total cost per unit. 843 01:16:27.100 --> 01:16:33.100 Its average total cost often falls spectacularly from large scale production. 844 01:16:33.100 --> 01:16:37.100 not the total, the average total, the total cost per unit 845 01:16:37.100 --> 01:16:41.100 okay, alright, this is enough for you to absorb this time 846 01:16:41.100 --> 01:16:45.100 we'll continue on with this stuff 847 01:16:45.100 --> 01:16:49.100 and I'll give you back your exams