WEBVTT NOTE The Firm 1 00:00:00.000 --> 00:00:05.000 Okay, we've got a lot to cover. It's getting to the end of the term. I can't believe it. 2 00:00:05.000 --> 00:00:08.000 Anyway, this is the way it is. 3 00:00:08.000 --> 00:00:18.000 Okay, we have dollars, the usual demand curve, which we carried over from the first part of the course. 4 00:00:18.000 --> 00:00:21.000 Price on the y-axis, quantity on the x-axis. 5 00:00:21.000 --> 00:00:27.000 The demand curve is falling. Total revenue can either go up or down, depending on the elasticity. 6 00:00:27.000 --> 00:00:39.000 TR is equal to price times quantity, and the other curve here we have dollars on the y-axis, 7 00:00:39.000 --> 00:00:40.000 quantity on the x-axis. 8 00:00:40.000 --> 00:00:45.160 We now have a TR curve, which can either go up or down, except it obviously can only go 9 00:00:45.160 --> 00:00:48.360 up from the point of origin, since it starts at zero. 10 00:00:48.360 --> 00:00:56.120 If you produce and sell zero TV sets, like I sell no TV sets, and therefore my total 11 00:00:56.120 --> 00:00:58.560 Total revenue from selling TV sets is zero. 12 00:00:58.560 --> 00:01:04.240 We start at the point of origin, zero quantity, zero total revenue, and a total revenue curve 13 00:01:04.240 --> 00:01:08.960 then has to go up from zero, and goes up, and then either goes up or down, except we're 14 00:01:08.960 --> 00:01:16.200 in some kind of peak trough situation, to the extent that it goes up, the demand curve 15 00:01:16.200 --> 00:01:17.200 is elastic. 16 00:01:17.200 --> 00:01:25.080 In other words, this is the area when the total revenue is increasing as quantity increases, 17 00:01:25.080 --> 00:01:40.080 This is the definition of the man curve being elastic, in other words, as quantity increases, like so, and total revenue is going up, this means that the man curve is elastic in that zone. 18 00:01:40.080 --> 00:01:43.080 So this is elastic the man curve. 19 00:01:43.080 --> 00:01:53.080 Then as it goes down, the definition of that is that the man curve is inelastic, in other words, as the quantity goes up, we now get into a situation where total revenue declines. 20 00:01:53.080 --> 00:02:08.080 And so, let's say here, as the state total revenue is now less, so in that situation we have an inelastic demand curve, and that goes up again, elastic, and then inelastic. 21 00:02:08.080 --> 00:02:14.080 So in the textbook, as I mentioned last time, all these problems are resolved because there's just one peak. 22 00:02:14.080 --> 00:02:20.080 In other words, the total revenue curve is drawn like this, and so in that situation it's very easy. 23 00:02:20.080 --> 00:02:33.080 If it's elastic here, then it becomes inelastic, but it doesn't have to be only one peak, it could be several peaks, so I'm drawing it this way to show that in real life it can be multi-peak. 24 00:02:33.080 --> 00:02:43.080 Okay, so you have the total revenue curve, which goes like that, meaning you don't know whether it's going up or down at any given moment. 25 00:02:43.080 --> 00:02:44.080 It could be either way. 26 00:02:44.080 --> 00:02:50.680 The total cost curve, which I went through last time, is always going up. 27 00:02:50.680 --> 00:02:55.880 Total cost curve starts off at zero, the point of origin, regardless of what the book says. 28 00:02:55.880 --> 00:03:02.880 In other words, if I am producing no TV sets, I produce no TV sets, I sell no TV sets, therefore 29 00:03:02.880 --> 00:03:06.980 my cost incurred in producing TV sets is zero. 30 00:03:06.980 --> 00:03:08.920 I start at the point of origin. 31 00:03:08.920 --> 00:03:10.520 All the rest of the stuff is purely short run. 32 00:03:10.520 --> 00:03:16.880 In other words, if I happen to be on a motorola producing TV and I'm retooling for six months 33 00:03:16.880 --> 00:03:19.800 because the TV sets aren't selling, I might be having fixed costs, because there really 34 00:03:19.800 --> 00:03:23.840 are no fixed costs in these sort of long run sets, okay? 35 00:03:23.840 --> 00:03:24.840 Yeah? 36 00:03:24.840 --> 00:03:31.160 Well, not if you're not in the business, I mean, you don't have to be in, nobody's compelling 37 00:03:31.160 --> 00:03:33.680 you to be in the business of selling TV sets, okay? 38 00:03:33.680 --> 00:03:39.560 In other words, I'm not, obviously in some short run situations, before you're, as you're 39 00:03:39.560 --> 00:03:43.120 You're gearing up, you have costs and then you have revenue. 40 00:03:43.120 --> 00:03:46.160 But there's nothing to compel you in the long run to stay in business if you're not selling 41 00:03:46.160 --> 00:03:47.160 anything. 42 00:03:47.160 --> 00:03:50.280 The point is that there are no fixed costs after a short run. 43 00:03:50.280 --> 00:03:54.880 There are short run fixed costs, but there are no real fixed costs in any real philosophic 44 00:03:54.880 --> 00:03:56.360 sense so to speak. 45 00:03:56.360 --> 00:04:03.560 Also, the variability of the costs are varied for any given unit, any given plant. 46 00:04:03.560 --> 00:04:07.360 Plants are more or less fixed, machines are less fixed, et cetera, et cetera. 47 00:04:07.360 --> 00:04:12.700 So, there are different divisibilities. I'll get into that later on today. But the point 48 00:04:12.700 --> 00:04:18.880 is there are no fixed costs. Nothing is fixed. If you're losing money in this business, you 49 00:04:18.880 --> 00:04:23.160 get the hell out, you sell the plant, you close down, you sell the plant, you sell it 50 00:04:23.160 --> 00:04:29.000 for scrap if necessary. You're firing somebody, you stop, you break your lease, you leave, 51 00:04:29.000 --> 00:04:33.400 or you transfer the lease to somebody else, and then you get out. So, so-called fixity 52 00:04:33.400 --> 00:04:42.040 is only very short run. There's nothing imposed upon you by the divine commandment that some 53 00:04:42.040 --> 00:04:45.040 things are fixed and other things are variable. Everything is variable at the point in time. 54 00:04:45.040 --> 00:04:50.560 All costs are variable at different degrees. Some costs are easier to get rid of than others. 55 00:04:50.560 --> 00:04:56.200 For example, if you're in the TV business and you decide to get out, you can immediately 56 00:04:56.200 --> 00:05:20.500 The aim of every firm is to maximize its profits or to minimize its losses, and therefore they're 57 00:05:20.500 --> 00:05:24.100 trying to get in a situation where there's the biggest distance between total revenue 58 00:05:24.100 --> 00:05:54.100 to maximize PR minus PC or profits. If there are luck holes in a good shape, this will be positive. In some cases, it can be negative. In some cases, you might have this kind of a situation. A total cost curve like that and a total revenue curve like that, then you're in really bad shape. Whatever you do, you're going to lose money. Eventually, of course, you go out of business. You raise tuition. 59 00:05:54.100 --> 00:05:57.100 That's not a market activity. 60 00:05:57.100 --> 00:06:03.660 So anyway, the maximum profit point of production you try to produce so that you maximize your 61 00:06:03.660 --> 00:06:07.980 profit, the maximum profit, one of the attributes of maximum profit point of production is that 62 00:06:07.980 --> 00:06:13.340 the slope of the tangent of total revenue and total cost are the same. 63 00:06:13.340 --> 00:06:21.180 So that if the slope of the tangent of TR and TC are the same, then you've got marginal 64 00:06:21.180 --> 00:06:32.740 Marginal revenue is equal to marginal cost. Marginal revenue is defined as delta TR over 65 00:06:32.740 --> 00:06:39.260 delta Q. In other words, if you produce one more item, one more TV set, one more package 66 00:06:39.260 --> 00:06:43.060 of nails, whatever you're selling, produce one more item. How much more total revenue 67 00:06:43.060 --> 00:06:48.740 will be brought in by that one more item? That's essentially the slope of the tangent. 68 00:06:48.740 --> 00:06:57.820 If you have an infinitesimal degree, the delta becomes infinitesimal and becomes dT or dQ. 69 00:06:57.820 --> 00:07:04.060 Marginal cost is also, the reason why I prefer to stick to delta is that in real life, nothing 70 00:07:04.060 --> 00:07:05.060 is infinitesimal. 71 00:07:05.060 --> 00:07:10.100 In human action, buying or selling or producing, it's not infinitesimally small, infinitesimally 72 00:07:10.100 --> 00:07:11.100 small. 73 00:07:11.100 --> 00:07:12.900 This is dTc over dQ. 74 00:07:12.900 --> 00:07:18.940 So, in other words, if you produce and sell one more unit of the item, how much will this 75 00:07:18.940 --> 00:07:20.900 extra unit cost you? 76 00:07:20.900 --> 00:07:25.100 And so, the maximum profit point is when the two are more or less equal, when the delta, 77 00:07:25.100 --> 00:07:27.380 the marginal revenue and marginal cost are equal. 78 00:07:27.380 --> 00:07:32.980 Now the thing is we should not make too much of this because once you realize there can 79 00:07:32.980 --> 00:07:37.500 be more than one peak, as the textbooks never realize, then you can also have a minimal 80 00:07:37.500 --> 00:07:38.500 profit. 81 00:07:38.500 --> 00:07:42.420 Profit. It could be in this situation, the tangents are equal here, the slope of the 82 00:07:42.420 --> 00:07:48.740 tangent is equal and yet you're in very bad shape. Also equal up here, you don't know 83 00:07:48.740 --> 00:07:54.380 off-hand which is bigger, this or that, unless you actually inspect the data and find out. 84 00:07:54.380 --> 00:07:59.300 So the marginal revenue equal marginal cost criterion is a very weak one. It only applies 85 00:07:59.300 --> 00:08:06.060 if you have only one peak. And it's better if you have the data, if you're a businessman, 86 00:08:06.060 --> 00:08:09.740 It's much better to figure out what the total is and not worry about the margin. 87 00:08:09.740 --> 00:08:13.020 Really the only important thing about the margin is that it emphasizes the fact that 88 00:08:13.020 --> 00:08:17.380 every step that a businessman takes, every decision a businessman takes, every new unit 89 00:08:17.380 --> 00:08:20.660 that he produces, he has to worry about covering costs. 90 00:08:20.660 --> 00:08:24.940 He has to figure he's not going to do it unless at least he covers costs, his revenue and 91 00:08:24.940 --> 00:08:26.580 costs are equal for this decision. 92 00:08:26.580 --> 00:08:29.900 Hopefully the cost is greater and the revenue is greater than the cost. 93 00:08:29.900 --> 00:08:34.820 That's the major, philosophically important, so to speak, of concentrating on the margin. 94 00:08:34.820 --> 00:08:39.820 The rest of it is mostly overblown, and the importance is really overblown of this. 95 00:08:39.820 --> 00:08:48.820 Okay, average, average revenue is TR over Q. 96 00:08:48.820 --> 00:08:53.820 In other words, if you want to find out, if you're producing, you sell, if you're producing, sell 100 units of something, 97 00:08:53.820 --> 00:08:57.820 100 packages of Wheaties or 100 loaves of bread or whatever, what's your average revenue? 98 00:08:57.820 --> 00:09:02.820 It's going to be the total you get, total income divided by the quantity. 99 00:09:02.820 --> 00:09:08.100 and the income per loaf of bread or income per TV set, which of course is the same thing 100 00:09:08.100 --> 00:09:09.100 as the price. 101 00:09:09.100 --> 00:09:12.860 In other words, T times Q is equal to TR. 102 00:09:12.860 --> 00:09:19.220 So average revenue is the same thing as price, it's another name for price of something. 103 00:09:19.220 --> 00:09:24.540 If somebody sells ten loaves of Wonder Bread and gets ten bucks for it, it means the price 104 00:09:24.540 --> 00:09:29.020 of the Wonder Bread, the average revenue of the Wonder Bread is a dollar per loaf. 105 00:09:29.020 --> 00:09:40.020 So this is our old friend the demand curve. This is the demand curve, the price curve so to speak, relating price and quantity. 106 00:09:40.020 --> 00:09:49.020 Marginal revenue, I mean average cost, is equal to total cost per unit, total cost divided by Q. 107 00:09:49.020 --> 00:09:55.020 Also you can call it average total cost to clearly distinguish, we're not talking about average fixed cost, average variable, all this sort of nonsense. 108 00:09:55.020 --> 00:09:58.020 I will not talk about fixing variable costs from now on. 109 00:09:58.020 --> 00:10:03.020 When I talk about average cost, it's average total cost, average cost, total cost per unit. 110 00:10:03.020 --> 00:10:10.020 It costs you $100,000 to produce and sell 10,000 items, and therefore the cost per item is 10 bucks. 111 00:10:10.020 --> 00:10:13.020 That sort of thing. 112 00:10:13.020 --> 00:10:16.020 Okay, now the relationship between marginal and average. 113 00:10:16.020 --> 00:10:20.020 There's a certain relationship between all margins and all averages, and we'll get to that later. 114 00:10:20.020 --> 00:10:24.020 We'll get to the labor market and the factory production market, too. 115 00:10:24.020 --> 00:10:31.020 It's a purely mathematical relationship. It has nothing to do with economics, but it's used in economics, so we should go through it. 116 00:10:31.020 --> 00:10:35.020 The relationship is as follows. 117 00:10:35.020 --> 00:10:39.020 Supposing, for example, we take the average height of this class. 118 00:10:39.020 --> 00:10:44.020 Each of us has a certain height. We total all the heights, and we divide it by whatever it is. 119 00:10:44.020 --> 00:10:47.020 It's 20 people, and we get the average height. 120 00:10:47.020 --> 00:10:51.020 Two basketball players walk in, and seven footers. 121 00:10:51.020 --> 00:11:00.020 Then we take another average and of course it's going to pull up the average, not as much as 7 feet, but it's going to pull it up from whatever it is, 5'8 or whatever it is, to 5'9 or something. 122 00:11:00.020 --> 00:11:26.020 In other words, if an average, if an average of x is increasing, then the marginal x is higher than the average, the average of x. 123 00:11:26.020 --> 00:11:31.140 In other words, if you see an average going, if an average is increasing, like the average 124 00:11:31.140 --> 00:11:36.660 height of a class increases from now to a half hour from now, it means a new guy coming 125 00:11:36.660 --> 00:11:40.220 in, new people coming in, are higher than the average. 126 00:11:40.220 --> 00:11:41.220 That's why the average is going up. 127 00:11:41.220 --> 00:11:45.380 In other words, the increased margin pulls the average up. 128 00:11:45.380 --> 00:11:50.060 So if you have an average of anything, it's not just the height, it applies to anything. 129 00:11:50.060 --> 00:11:55.820 Average income, average weight, average whatever, intelligence quotient, whatever happens to 130 00:11:55.820 --> 00:12:05.820 If the average is going up, that means that the marginal of the thing, average of x, the marginal of x is higher than the average, whatever it is. 131 00:12:05.820 --> 00:12:17.820 On the other hand, the same thing applies to the other direction. All these laws are symmetrical. 132 00:12:17.820 --> 00:12:24.820 If we take the average height and two midgets walk in, two four-footers, it's going to pull down the average. 133 00:12:24.820 --> 00:12:40.580 If the average of something is decreasing, then the marginal of x is less than the average 134 00:12:40.580 --> 00:12:41.580 of x. 135 00:12:41.580 --> 00:12:54.380 So, in other words, if you see an average of something decreasing, it means that the 136 00:12:54.380 --> 00:13:01.380 The margin is pulling down the average. These two midgets or three midgets, whatever it is, are pulling down the class average in height. 137 00:13:01.380 --> 00:13:05.380 So, this is the other law. It's symmetrical to the first one. 138 00:13:05.380 --> 00:13:10.380 So that means if you have an average of anything as decreasing, it means that the margin is below the average. 139 00:13:10.380 --> 00:13:18.380 Here we have an average of something. It doesn't matter what it is. Let's say height. It doesn't matter. 140 00:13:18.380 --> 00:13:27.380 And this average is going up, so it means that the margin is above it somewhere, and if the average is going down, it means the margin is below it somewhere. 141 00:13:27.380 --> 00:13:30.380 The margin is the average. 142 00:13:30.380 --> 00:13:42.380 Well, okay, if in that case, this is pretty obvious, but in that case it means that when the average reaches a peak, it reaches a peak point, which means it's constant for that moment, of course. 143 00:13:42.380 --> 00:13:50.380 And the average utility, it must mean that the marginal is equal to the average, it's the only way you can cut through, you can't leap across the dimension here. 144 00:13:50.380 --> 00:13:56.380 So it must mean that at the point where the average flattens out before it falls, the marginal is equal to it. 145 00:13:56.380 --> 00:14:04.380 In other words, this follows from these two points, these two axioms here, whatever you want to call them, propositions. 146 00:14:04.380 --> 00:14:17.220 So, therefore, when the average of x is at a peak, in other words, when it's constant, 147 00:14:17.220 --> 00:14:22.820 then the average of x is equal to the marginal of x. 148 00:14:22.820 --> 00:14:24.900 And also it works for the trough point. 149 00:14:24.900 --> 00:14:32.700 In other words, the average is going down, the average is something, and then it goes 150 00:14:32.700 --> 00:14:36.500 When it goes up and it goes down, the margin is below it somewhere, the marginals, when 151 00:14:36.500 --> 00:14:40.840 the average is going up, the marginals above it, the average. 152 00:14:40.840 --> 00:14:45.100 This means that when the average flattens out and becomes a trough of the trough point, 153 00:14:45.100 --> 00:14:47.980 the marginals must be equal to it. 154 00:14:47.980 --> 00:14:57.180 So this is, okay, so when the A of X is either a P or a trough, because at a peak or a trough, 155 00:14:57.180 --> 00:15:01.060 the average is constant for that moment. 156 00:15:01.060 --> 00:15:04.820 and the average of x is equal to the margin. 157 00:15:04.820 --> 00:15:06.860 This applies to all averages and all marginals. 158 00:15:06.860 --> 00:15:10.940 FAT-MAC applies to everything in life, just in economics we just build a few things here, 159 00:15:10.940 --> 00:15:12.540 but you can carry it over to all of life now. 160 00:15:12.540 --> 00:15:18.340 You have this great piece of knowledge which can serve you in good stead forever in all 161 00:15:18.340 --> 00:15:23.500 fields of endeavor, height, weight, IQ test or whatever. 162 00:15:23.500 --> 00:15:34.700 In the case of microeconomics, the average costs, as we'll see in a minute, average 163 00:15:34.700 --> 00:15:39.020 costs tend to have a U-shape, something like that, you'll see why, average total cost 164 00:15:39.020 --> 00:15:43.020 or average cost. 165 00:15:43.020 --> 00:15:44.020 Something like that. 166 00:15:44.020 --> 00:15:47.180 In other words, it declines, reaches a throw-off point, and then goes up. 167 00:15:47.180 --> 00:15:52.780 This is dollars on the y-axis, quantity of goods on the x-axis. 168 00:15:52.780 --> 00:16:02.780 We haven't demonstrated this yet. I will demonstrate this a little later. If it has this kind of a U-shape, then marginal cost will always be below it when it's declining. 169 00:16:02.780 --> 00:16:11.780 It will always be above it when it's going up, because it follows. When the average of anything falls, the marginal is below it, below the average. 170 00:16:11.780 --> 00:16:14.780 When the average of anything is going up, the marginal has to be above the average. 171 00:16:14.780 --> 00:16:18.780 When the average of anything is at a trough point, the marginal is equal to it. 172 00:16:18.780 --> 00:16:24.080 So, therefore, marginal costs, if the average costs really have some kind of a U-shape, 173 00:16:24.080 --> 00:16:28.140 kind of shape, then the marginal costs will be something like that and they will equal 174 00:16:28.140 --> 00:16:36.820 each other at the trough point. 175 00:16:36.820 --> 00:16:48.020 For revenue, it's a little bit different because since the demand curve is always falling, 176 00:16:48.020 --> 00:16:52.020 The man is equal to average revenue, so the average revenue is always falling. 177 00:16:52.020 --> 00:16:55.020 This is a rising average revenue curve. 178 00:16:55.020 --> 00:17:00.020 So the marginal revenue will always be below it. 179 00:17:00.020 --> 00:17:02.020 In other words, this average revenue is always falling. 180 00:17:02.020 --> 00:17:04.020 This means the marginal revenue is always below it. 181 00:17:04.020 --> 00:17:07.020 It will be like this, matter of fact. 182 00:17:07.020 --> 00:17:10.020 Eventually it will hit the x-axis for that matter. 183 00:17:10.020 --> 00:17:12.020 It will keep going like that. 184 00:17:12.020 --> 00:17:16.020 So this accounts for the shape of the marginal curve in the book. 185 00:17:16.020 --> 00:17:20.660 In other words, given the average curve, because the man curve is always falling, as I've said 186 00:17:20.660 --> 00:17:24.460 to that, the marginal curve is always falling, it will always be below it and will actually 187 00:17:24.460 --> 00:17:28.900 fall more steeply, you could say that, and if the average curve is U-shaped, and I haven't 188 00:17:28.900 --> 00:17:32.940 demonstrated that yet, then the marginal curve will be something like that, hitting, intersecting 189 00:17:32.940 --> 00:17:34.540 at the trough point. 190 00:17:34.540 --> 00:17:41.300 So this is all really mathematics, it's now applied to microeconomics, and later on we'll 191 00:17:41.300 --> 00:17:45.300 Let's see how this applies to productivity curves, things like that. 192 00:17:45.300 --> 00:17:49.300 Okay, let's get to the average cost curve, then, 193 00:17:49.300 --> 00:17:53.300 why a few shake or whatever. When you think of economy 194 00:17:53.300 --> 00:17:57.300 of large-scale production, those of you who have walked with the idea of a total cost curve 195 00:17:57.300 --> 00:18:01.300 is always going up, and you say, no, no, but total cost, how about a normal meal plan, isn't it less 196 00:18:01.300 --> 00:18:05.300 costly to have a large-scale production? It's true, but for average cost that you're talking 197 00:18:05.300 --> 00:18:09.300 about, average total cost. 198 00:18:09.300 --> 00:18:14.460 Let's look at the average course curve, it's not as simple as you might think, why it's 199 00:18:14.460 --> 00:18:15.460 something like U-shape. 200 00:18:15.460 --> 00:18:24.220 Now we get to some more philosophic mathematics, so to speak, this is philosophy of life of 201 00:18:24.220 --> 00:18:27.380 mathematics applied to it. 202 00:18:27.380 --> 00:18:33.620 We have it in real life, so to speak, law of cause and effect, which essentially says 203 00:18:33.620 --> 00:18:48.620 given the causal factors, given a certain quantity of causal factors, it will yield a certain result, a certain effect, and this cause and effect relationship can be replicated at any time or place. 204 00:18:48.620 --> 00:18:59.620 In other words, you can set side by side, you can produce whatever it is, you can produce copper sulfate in a certain way, you can produce the same copper sulfate next week or two blocks away and so forth and so on. 205 00:18:59.620 --> 00:19:09.620 So this is a basic law of life, that equal causes yield equal effects, that they have a natural law situation, called natural law of nature, natural law situation. 206 00:19:09.620 --> 00:19:22.620 Okay, we can express this, we can express this natural law situation in production by a mathematical formula, by a generalized mathematical formula called the production function. 207 00:19:22.620 --> 00:19:28.060 It's a very general law, but it expresses certain basic truths. 208 00:19:28.060 --> 00:19:34.060 When a production function says it relates, it says as follows, given, it applies to all 209 00:19:34.060 --> 00:19:35.060 production of anything. 210 00:19:35.060 --> 00:19:39.300 It really applies to any kind of action for that matter, any kind of quantitative action 211 00:19:39.300 --> 00:19:40.300 of any sort. 212 00:19:40.300 --> 00:19:42.460 I mean, to buy a sandwich, you have to do certain things. 213 00:19:42.460 --> 00:19:43.460 You have to go downstairs. 214 00:19:43.460 --> 00:19:44.460 You have to go to Michelangelo's. 215 00:19:44.460 --> 00:19:46.460 They've got the sandwich and all that sort of thing. 216 00:19:46.460 --> 00:19:48.660 You pay a certain amount of money, you leave that out. 217 00:19:48.660 --> 00:19:51.660 It's a physical production function. 218 00:19:51.660 --> 00:19:57.460 What you're saying is this, to produce anything, you need certain end factors of production, 219 00:19:57.460 --> 00:20:00.660 you need a certain amount of labor, land, capital, certain types and so forth and so 220 00:20:00.660 --> 00:20:01.660 on. 221 00:20:01.660 --> 00:20:07.340 A certain quantity of each factor, a factor x, a certain quantity alpha, whatever the 222 00:20:07.340 --> 00:20:14.260 quantity is, five of it, three of it, it will differ from good to good, it depends on each 223 00:20:14.260 --> 00:20:16.780 good and service, it depends on the technology of it. 224 00:20:16.780 --> 00:20:33.460 The alpha of x, combined with, this is a symbol for combined with, combined with beta, a certain 225 00:20:33.460 --> 00:20:41.180 quantity of y, factor y, combined with a certain gamma, a certain quantity of factor z, combined 226 00:20:41.180 --> 00:20:48.180 Combine with a bunch of other factors, dot dot dot, will yield a certain quantity of 227 00:20:48.180 --> 00:20:50.500 a product. 228 00:20:50.500 --> 00:20:55.740 Q of, I don't know, what's, Q of P? 229 00:20:55.740 --> 00:21:01.740 P is usually price, let's make it R. Q of R, Q of a certain product. 230 00:21:01.740 --> 00:21:07.900 In other words, you take a certain number, a certain amount of factor of X, combine it 231 00:21:07.900 --> 00:21:20.900 In a certain way, with a certain amount of factor Y combined with a certain amount of factor Z, step by step you will get five eggs or three TV sets or whatever it happens to be. You get a certain quantity of a product. 232 00:21:20.900 --> 00:21:28.900 This applies to any product of any sort. It doesn't matter what the actual service happens to be. 233 00:21:28.900 --> 00:21:35.900 This is a generalized production function. Since you have a law of cause and effect, you can replicate it. You can put it side by side somewhere and duplicate it. 234 00:21:35.900 --> 00:21:46.040 So you'll have then alpha of x combined with beta of y combined with gamma of z, etc. 235 00:21:46.040 --> 00:21:51.460 Side by side will produce another q of r, another three t v sets or another 28 loaves 236 00:21:51.460 --> 00:21:53.260 of wonder bread, whatever it happens to be. 237 00:21:53.260 --> 00:21:56.900 So this means that you can keep adding indefinitely. 238 00:21:56.900 --> 00:22:00.420 So therefore, instead of doing that, of course, you can multiply each of these factors by 239 00:22:00.420 --> 00:22:01.420 n. 240 00:22:01.420 --> 00:22:08.420 So this means that n times alpha, minus n times beta, minus n times gamma will yield n times the product. 241 00:22:08.420 --> 00:22:12.420 This is purely, this follows the law of cause and effect. 242 00:22:14.420 --> 00:22:19.420 So this is our generalized production function. Those of you who are mathematical mavens, 243 00:22:19.420 --> 00:22:22.420 this is also called a linear homogeneous production function. 244 00:22:22.420 --> 00:22:26.420 Don't ask me what this means, because I'll just state it. 245 00:22:31.420 --> 00:22:40.420 So, this means that from the physical point of view, just from the point of view of physical product, physical factors or whatever, 246 00:22:40.420 --> 00:22:49.420 if you're a business firm now, to get back to the firm, and you're hiring factors and you're producing certain things and getting the product, 247 00:22:49.420 --> 00:22:54.420 this means that the average cost of everything should be constant. 248 00:22:54.420 --> 00:23:11.420 should be constant. In other words, if to produce, I don't know, produce 100 loaves of wonder bread, you need alphas or whatever, to produce a thousand, you need 10 times as much, and we've just said this through our basic law of linear homogeneous production sponge. 249 00:23:11.420 --> 00:23:26.420 So this means that the average therefore cost, this is dollars, means you need five times as much of everything to produce five times of a product, so therefore it should mean that the average cost is horizontal. 250 00:23:26.420 --> 00:23:30.420 The average total cost would be horizontal. 251 00:23:30.420 --> 00:23:34.420 And since it's obviously not horizontal, the question is how come? 252 00:23:34.420 --> 00:23:41.140 come. Here we have a real problem. It obviously does not cost. If you want to produce one 253 00:23:41.140 --> 00:23:46.380 car a year, you're not going to build a $100 million automobile plant with all the equipment 254 00:23:46.380 --> 00:23:50.320 and grind out with one car because you have an astronomical cost per car. You have a huge 255 00:23:50.320 --> 00:23:55.900 fixed cost in situations like that. One thing that violates, by the way, of course, is when 256 00:23:55.900 --> 00:24:01.980 the price goes up, as we'll see later on, even more. If you keep producing more and 257 00:24:01.980 --> 00:24:06.300 If you're going to buy more of this thing, grinding out many n's, in other words, losing 258 00:24:06.300 --> 00:24:09.780 ten loads of money, about ten cars, a hundred, a thousand, a million, you're going to start 259 00:24:09.780 --> 00:24:15.060 bidding up the demand curves of the various factors of labor, in other words, you're buying 260 00:24:15.060 --> 00:24:20.100 more, demanding more labor on raw materials or land, you're going to bid the prices up, 261 00:24:20.100 --> 00:24:24.900 so the wage rates and raw material prices and all those things will go up. 262 00:24:24.900 --> 00:24:30.400 So eventually, even if everything was constant, because of the prices going up, the price 263 00:24:30.400 --> 00:24:41.400 The price of the factors of production, the cost from the point of view of price, in other words, the price of labor, the price of land, low material, you'll have something like that, so you'll have an average cost that will then go up. 264 00:24:41.400 --> 00:24:49.400 But the real problem is what about the sloping cost, which we know, we know of course that the average cost falls over a long distance when you start producing. 265 00:24:49.400 --> 00:24:52.400 So the question is, where does that come from? Why does it have a falling average cost fair? 266 00:24:52.400 --> 00:24:59.400 Why is it more economic to have a huge assembly line for automobiles producing a million cars a year instead of five cars a year? 267 00:24:59.400 --> 00:25:08.120 Cards a year. Why is it much costlier to have a small automobile plant? And we haven't explained 268 00:25:08.120 --> 00:25:13.240 that yet. So in other words, with the philosophy, we have the constant average cost curve, and 269 00:25:13.240 --> 00:25:18.360 then knowing that an increase in demand curve will raise the price of raw materials and 270 00:25:18.360 --> 00:25:23.240 labor etc., we're going to explain the average cost curve going up at the toe of the end. 271 00:25:23.240 --> 00:25:28.240 What we can't explain yet is why it falls on the early parts of production. 272 00:25:33.240 --> 00:25:40.240 The reason why it falls, allegedly violating all of this law of linear homogeneous production factor, doesn't really violate it. 273 00:25:40.240 --> 00:25:45.240 The problem is, you can't multiply everything by n in real life. That's the problem. 274 00:25:45.240 --> 00:25:49.240 In other words, you can't take n times nq. 275 00:25:49.240 --> 00:25:56.240 You can't multiply each thing by n, because each factor of production is a different divisibility. 276 00:25:56.240 --> 00:25:59.240 This is the so-called indivisibility problem. 277 00:25:59.240 --> 00:26:05.240 You can, for example, multiply paperclips by n. 278 00:26:05.240 --> 00:26:10.240 If you're increasing the production of something by tenfold, you're going to have ten times as many paperclips. 279 00:26:10.240 --> 00:26:11.240 There's no problem with that. 280 00:26:11.240 --> 00:26:16.240 Or ten times as many nails, or something like that, which are very divisible. 281 00:26:16.240 --> 00:26:20.360 In other words, some factors of production, some capital goods are very divisible, others 282 00:26:20.360 --> 00:26:23.400 are very indivisible, just the nature, the technological nature of them is very indivisible. 283 00:26:23.400 --> 00:26:26.080 You can't multiply a plant by a factory by ten, right? 284 00:26:26.080 --> 00:26:31.560 You can have ten times as many machines, maybe, but you can't have ten times as many factories. 285 00:26:31.560 --> 00:26:36.720 The most, the famous case of a very indivisible, there are different degrees of indivisibility. 286 00:26:36.720 --> 00:26:39.680 This is why I'm getting back to this gentleman's point about fixed costs. 287 00:26:39.680 --> 00:26:42.800 There are different degrees of fixity, there are different degrees of variability. 288 00:26:42.800 --> 00:26:47.120 The problem with the textbook they say some costs are fixed and others are variable. Everything 289 00:26:47.120 --> 00:26:52.800 is variable but at different degrees. For example, the most famous case of a very indivisible 290 00:26:52.800 --> 00:26:57.400 capital good is a railroad track. Let's say you have a railroad going from here to Boston 291 00:26:57.400 --> 00:27:01.120 and you're increasing, you're doubling the amount of shipments on it because you have 292 00:27:01.120 --> 00:27:05.320 more business. Well, you can double the number of railroad cars maybe. You can double the 293 00:27:05.320 --> 00:27:08.720 number of railroad workers and engineers and firemen and stuff. You can't double the track. 294 00:27:08.720 --> 00:27:15.720 The track, the double track is a big thing, a big deal. It takes a long time. You have to lay the track and all the rest of it. It's not very easy. 295 00:27:15.720 --> 00:27:22.720 You have different degrees of indivisibility. Railroad track is one of the least indivisible things I can think of, one of the most indivisible things. 296 00:27:22.720 --> 00:27:29.720 Factories are quite indivisible. Machines are less indivisible than different machines. 297 00:27:29.720 --> 00:27:35.720 Law material is very divisible, you can get more, you know, law material coming through pretty easily. 298 00:27:35.720 --> 00:27:38.720 Labor has different degrees of divisibility, et cetera, et cetera. 299 00:27:38.720 --> 00:27:41.720 And some things like paper clips are very divisible. 300 00:27:41.720 --> 00:27:45.720 So, in practice, you can't increase everything by n. 301 00:27:45.720 --> 00:27:47.720 Some things can be doubled, other things can't. 302 00:27:47.720 --> 00:27:49.720 Some things can be tripled easily. 303 00:27:49.720 --> 00:27:52.720 You can quadruple, say, this before you can double this. 304 00:27:52.720 --> 00:27:55.720 And so, it's because of that, because of these degrees of indivisibility, 305 00:27:55.720 --> 00:28:04.800 In other words, you start with a plant. Let's say you're producing automobile. You start 306 00:28:04.800 --> 00:28:09.920 with a huge plant with a big equipment and all the rest of the stuff before you can produce 307 00:28:09.920 --> 00:28:15.440 anything. You produce one car a year. You've got an enormous $100 million per car cost 308 00:28:15.440 --> 00:28:19.040 because you have this enormous cost in order to gear up those things because these are 309 00:28:19.040 --> 00:28:23.840 all very indivisible. You have a stratospheric average cost problem. As you keep increasing 310 00:28:23.840 --> 00:28:32.300 In other words, then you begin to have very rapidly decreasing as you start using this 311 00:28:32.300 --> 00:28:33.300 very indivisible machine. 312 00:28:33.300 --> 00:28:34.300 It's like a big computer. 313 00:28:34.300 --> 00:28:37.900 You have a huge mainframe computer, like in the old days, think you have to use it a lot 314 00:28:37.900 --> 00:28:41.880 to make it efficient, bring down like average cost per unit. 315 00:28:41.880 --> 00:28:48.600 As you increase the units of production, you have a very rapid fall in average cost as 316 00:28:48.600 --> 00:28:52.160 you keep tapping more and more of the indivisibility, you start using this very indivisible, it's 317 00:28:52.160 --> 00:28:59.320 It's like picking a $100 million machine or whatever and using it only once a year, one 318 00:28:59.320 --> 00:29:00.320 hour a year. 319 00:29:00.320 --> 00:29:01.320 It's crazy. 320 00:29:01.320 --> 00:29:03.800 It's a very high average cost per unit. 321 00:29:03.800 --> 00:29:08.360 As you keep using it, you lower the invisibility and as you keep increasing the quantity, more 322 00:29:08.360 --> 00:29:09.680 and more of the invisibility are tapped. 323 00:29:09.680 --> 00:29:13.280 In other words, you're using it in more and more capacity production. 324 00:29:13.280 --> 00:29:18.760 As you do that, you finally level it off and you finally begin to use it at capacity. 325 00:29:18.760 --> 00:29:21.920 Most entrepreneurs, when they're building a plant, are thinking of a certain range of 326 00:29:21.920 --> 00:29:25.600 production they're going to use it, you know, a hundred million cars a year or something. 327 00:29:25.600 --> 00:29:28.840 They will design a plant in such a way that it will be the most efficient or lowest average 328 00:29:28.840 --> 00:29:30.400 cost, more or less at a million a year. 329 00:29:30.400 --> 00:29:34.240 I mean, this would be a certain range, because it's not God-given, it's going to be the 330 00:29:34.240 --> 00:29:39.120 same number of cars for ten years or twenty years, but more or less they know the range. 331 00:29:39.120 --> 00:29:40.920 Nobody thinks of producing one car a year. 332 00:29:40.920 --> 00:29:46.280 When the automobile industry first started, they grew up in blacksmith shops around 1900, 333 00:29:46.280 --> 00:29:48.680 small blacksmith shops, bicycle shops. 334 00:29:48.680 --> 00:29:51.520 They produced one car a year or ten cars a year or something like that. 335 00:29:51.520 --> 00:29:52.520 They were geared for it. 336 00:29:52.520 --> 00:29:53.520 That was the most efficient. 337 00:29:53.520 --> 00:29:57.400 The lowest average cost is more or less at ten cars a year, but after they start going 338 00:29:57.400 --> 00:30:01.840 into mass production, the whole thing changes. 339 00:30:01.840 --> 00:30:05.240 So as you keep increasing the quantity, you finally get to the point where you're more 340 00:30:05.240 --> 00:30:08.200 or less using everything in capacity and you start overusing things. 341 00:30:08.200 --> 00:30:11.440 And as you keep going, you start overusing various products. 342 00:30:11.440 --> 00:30:14.280 You can't gear it in such a way that everything meshes together at once. 343 00:30:14.280 --> 00:30:18.320 So as you keep increasing the quantity, you start having problems with overuse, breakdowns 344 00:30:18.320 --> 00:30:24.060 of Equipment, and the average costs begin to turn up. 345 00:30:24.060 --> 00:30:29.740 And then you have, finally, as you get big mass production, the factor enters in of increasing 346 00:30:29.740 --> 00:30:34.260 the price of wages and more material, in other words, you have an average cost turning up 347 00:30:34.260 --> 00:30:37.540 because the price of the factors of production goes up. 348 00:30:37.540 --> 00:30:42.100 As a result of all this, you have something like a U-shaped average cost curve. 349 00:30:42.100 --> 00:30:44.900 Because of the problem of indivisibility, you have to get to the point where you're 350 00:30:44.900 --> 00:30:48.780 using up the indivisibility, you're tapping the, you know, using the capacity of all this 351 00:30:48.780 --> 00:30:49.780 fixed equipment. 352 00:30:49.780 --> 00:30:53.660 But there are different degrees of indivisibility, it's not just some things are fixed and other 353 00:30:53.660 --> 00:30:54.660 things are variable. 354 00:30:54.660 --> 00:31:00.900 Everything is variable except at different paces, at different rates, and so the best 355 00:31:00.900 --> 00:31:02.860 way to mesh them together is somewhere around here. 356 00:31:02.860 --> 00:31:07.340 It's still not totally meshed together because life doesn't work that way. 357 00:31:07.340 --> 00:31:11.580 So you have something like a U-shaped average cost curve, that's the final conclusion, 358 00:31:11.580 --> 00:31:17.500 And more or less, you hear it, of course you're usually operating around here, in this area. 359 00:31:17.500 --> 00:31:22.520 And if you talk to a business man, if an economist talks to a business man about their falling 360 00:31:22.520 --> 00:31:25.420 average cost, they don't usually know what you're talking about because they don't think 361 00:31:25.420 --> 00:31:29.660 in terms of producing one car a year, or two cars a year, obviously they're thinking in 362 00:31:29.660 --> 00:31:35.140 terms of producing a million or so, they're not geared in these kinds of hypothetical 363 00:31:35.140 --> 00:31:36.140 situations. 364 00:31:36.140 --> 00:31:39.780 So most businessmen think, of course, average cost is more or less constant because they're 365 00:31:39.780 --> 00:31:43.420 We're dealing in a zone here, more or less in this area. 366 00:31:43.420 --> 00:31:51.380 As a matter of fact, probably empirically, in most situations, the average cross-curve, 367 00:31:51.380 --> 00:31:54.180 there's nothing that says it has to be U-shaped. 368 00:31:54.180 --> 00:31:59.700 All we know is it starts off very high, it declines, it reaches a cross-point and then 369 00:31:59.700 --> 00:32:00.700 goes up again. 370 00:32:00.700 --> 00:32:05.300 And so usually empirically, it's generally something like this, goes down like this and 371 00:32:05.300 --> 00:32:08.580 there's a plateau and then it goes up. 372 00:32:08.580 --> 00:32:13.480 So most businessmen think of their average cost as constant, because they're dealing 373 00:32:13.480 --> 00:32:16.460 of course in practical reality in this plateau area. 374 00:32:16.460 --> 00:32:21.680 They don't deal in the areas where they start having big increases in costs or areas where 375 00:32:21.680 --> 00:32:23.820 they're only producing five cars a year or something. 376 00:32:23.820 --> 00:32:28.420 So more or less you have this plateau situation. 377 00:32:28.420 --> 00:32:32.980 And in this situation of course marginal cost will be somewhere below it. 378 00:32:32.980 --> 00:32:36.940 When average costs are falling, marginal costs are below it, usually around here somewhere 379 00:32:36.940 --> 00:32:46.940 marginal cost will be higher here, and of course it will intersect at the trough point 380 00:32:46.940 --> 00:32:51.940 and again, too much is made of this in a textbook, I think this is a great thing to worry about the intersection 381 00:32:51.940 --> 00:32:57.940 but basically the point is that marginal costs are set once you give an average cost 382 00:32:57.940 --> 00:33:02.940 and in this situation here, where there's a plateau, marginal cost will be identical to average cost in this whole range 383 00:33:02.940 --> 00:33:08.940 You have something like that, marginal cost like this, up like that, like that. 384 00:33:08.940 --> 00:33:13.940 So, this is why most businessmen, if they talk about marginal cost and average cost at all, which they usually don't, 385 00:33:13.940 --> 00:33:19.940 they say, well, it's all constant, it's all equal, and it is for them, and in the zone of practicality, it is equal. 386 00:33:19.940 --> 00:33:26.940 I mean, because this is the region they're dealing with 99% of the time. 387 00:33:26.940 --> 00:33:34.740 Okay, so this is the, this is basically the average cost, marginal cost, shtick. 388 00:33:34.740 --> 00:33:39.740 It's of some use, certainly, the idea of indivisibility is important. 389 00:33:39.740 --> 00:33:44.620 The average cost curve falling and then being constant and then going up again. 390 00:33:44.620 --> 00:33:50.100 And the idea of marginality is important as an idea of focusing on the fact that businessmen 391 00:33:50.100 --> 00:33:51.100 are interested in each decision. 392 00:33:51.100 --> 00:33:55.220 They want to make a profit on each decision, or at least not make losses on any given decision 393 00:33:55.220 --> 00:34:02.820 in their making during the course of the year. 394 00:34:02.820 --> 00:34:12.740 Now we take the maximum profit point, or the maximum profit diagram, remember in our total 395 00:34:12.740 --> 00:34:22.500 curve, where the total revenue is like that, and the total cost is like that, this is the 396 00:34:22.500 --> 00:34:23.500 maximum profit. 397 00:34:23.500 --> 00:34:31.500 In other words, businessmen, if they know the curves, which is a very big if, will tend to produce at this point, where the profit is at the maximum. 398 00:34:31.500 --> 00:34:40.500 Transposing that to the average marginal curve, we have then the demand curve is like this, let's say. 399 00:34:40.500 --> 00:34:42.500 Something like that. 400 00:34:42.500 --> 00:34:46.500 And here's the average cost curve and then whatever. 401 00:34:46.500 --> 00:34:51.500 And in this case, the marginal revenue curve would be like this. 402 00:34:51.500 --> 00:34:59.780 and marginal cost curve will come up like that and remember that given the various assumptions, 403 00:34:59.780 --> 00:35:05.580 given a one peak curve, okay, beginning about multi-peaks, given a one peak curve, and given 404 00:35:05.580 --> 00:35:09.380 this diagram, you can't automatically see what the maximum profit point is, you can in 405 00:35:09.380 --> 00:35:14.620 this diagram, pretty obvious, you know, this is the maximum profit point, given only this 406 00:35:14.620 --> 00:35:17.860 diagram, the only way you can figure out the maximum profit point is by taking marginal 407 00:35:17.860 --> 00:35:21.460 Marginal Revenue Equal Marginal Cost is the criterion, in other words, this point right 408 00:35:21.460 --> 00:35:23.360 here. 409 00:35:23.360 --> 00:35:28.740 This will be the point of maximum profit for the firm given these curves, given the situation. 410 00:35:28.740 --> 00:35:36.100 At this point, this point of production, let's say, this is a thousand widgets or whatever, 411 00:35:36.100 --> 00:35:40.060 at that point, this is where marginal revenue and marginal cost are equal, the only point 412 00:35:40.060 --> 00:35:47.180 where they're equal, at that point the total profit will be the following. 413 00:35:47.180 --> 00:36:03.620 Total Profit, it will be average revenue times Q, or price times Q, total revenue, minus, 414 00:36:03.620 --> 00:36:13.260 So this is, if you're looking at the averages, total revenue minus total cost, so this is 415 00:36:13.260 --> 00:36:24.100 total revenue is average revenue, average revenue times quantity minus average cost 416 00:36:24.100 --> 00:36:25.100 times quantity. 417 00:36:25.100 --> 00:36:30.820 So this is the way, this is the way total, this would be maximum profit point, where 418 00:36:30.820 --> 00:36:35.620 Now, it was at the point where marginal revenue and marginal cost are equal, average revenue 419 00:36:35.620 --> 00:36:41.220 times quantity, the total profit will be average revenue times quantity minus average cost 420 00:36:41.220 --> 00:36:42.220 times quantity. 421 00:36:42.220 --> 00:36:50.620 In other words, this is average revenue times quantity here, this figure, minus average 422 00:36:50.620 --> 00:36:52.260 cost down here times quantity. 423 00:36:52.260 --> 00:37:03.140 So this, the total profit will be this area here, in other words average revenue minus 424 00:37:03.140 --> 00:37:11.640 average cost times quantity, this will give you the total profit at the maximum profit 425 00:37:11.640 --> 00:37:12.640 point. 426 00:37:12.640 --> 00:37:17.740 In other words, at the point where marginal revenue and marginal cost are equal, you then 427 00:37:17.740 --> 00:37:24.220 take this, this minus this, this is on the point-of-demand curve, minus the point-of-the-total 428 00:37:24.220 --> 00:37:28.740 on the average cost curve, times quantity, giving you this area, this will be the same 429 00:37:28.740 --> 00:37:30.940 as that, as this line here. 430 00:37:30.940 --> 00:37:35.460 And this is a big, this is always big in the textbook, always giving you these examples 431 00:37:35.460 --> 00:37:41.940 of problems except for finding the maximum profit point, let's grind it out that way. 432 00:37:41.940 --> 00:37:46.460 In real life, of course, this is average to the total, why not go for the total, why worry 433 00:37:46.460 --> 00:37:47.460 about the average? 434 00:37:47.460 --> 00:37:50.820 This is the way it's done on the books. 435 00:37:50.820 --> 00:37:56.960 Given only this information, the maximum profit will be the point where these marginal revenue 436 00:37:56.960 --> 00:38:03.020 and marginal costs intersect, and at that point, the total profit will be this area. 437 00:38:03.020 --> 00:38:11.620 Of course, if you're making losses, then you're in an unfortunate situation, such as as follows. 438 00:38:11.620 --> 00:38:16.380 Here's the demand curve, and here's the average cost, and you're always below it, 439 00:38:16.380 --> 00:38:20.380 and you're in bad shape. 440 00:38:20.380 --> 00:38:24.380 This, I guess, will be the marginal cost 441 00:38:24.380 --> 00:38:28.380 coming up like that, the marginal revenue. This will be like the minimum 442 00:38:28.380 --> 00:38:32.380 loss point here. So you produce at this level, this will be the loss. 443 00:38:32.380 --> 00:38:36.380 Of course, if you keep on like this, you go out of business 444 00:38:36.380 --> 00:38:40.380 pretty quickly. I'm not going to hang around and make losses forever, but this 445 00:38:40.380 --> 00:38:44.380 would be the minimum loss point. This would be the area of loss then. 446 00:38:44.380 --> 00:38:51.580 textbook, at the point of intersection, marginal revenue and marginal cost, this would be the 447 00:38:51.580 --> 00:38:56.900 minimum loss point where the average cost minus average revenue times quantities at 448 00:38:56.900 --> 00:38:57.900 a minimum. 449 00:38:57.900 --> 00:39:02.700 Hopefully, of course, usually in the textbook, this is the example because you're assuming 450 00:39:02.700 --> 00:39:04.060 the firm is making a profit. 451 00:39:04.060 --> 00:39:07.340 It doesn't have to make a profit, nothing, there's no divine law, it doesn't have to 452 00:39:07.340 --> 00:39:08.340 make a profit. 453 00:39:08.340 --> 00:39:14.700 So, anyway, this is essentially production. The theory of production of the firm is essentially 454 00:39:14.700 --> 00:39:19.460 this, that the firm tries to make a maximum profit. A maximum profit is determined in 455 00:39:19.460 --> 00:39:27.420 a one peak curve situation, one peak total revenue curve, and be at a point where the 456 00:39:27.420 --> 00:39:30.860 slope of the tangents, in other words, marginal revenue and marginal cost are equal. So the 457 00:39:30.860 --> 00:39:37.700 marginal revenue and cost and marginal cost curves intersect, and at that curve, you can 458 00:39:37.700 --> 00:39:43.700 This line here in the total diagram is very simple. This is obviously much simpler. 459 00:39:43.700 --> 00:39:47.700 Just look at this. This is the profit, total profit, this minus that. 460 00:39:47.700 --> 00:39:57.700 In this curve it's more complicated. The area is subtract average revenue, average cost of average revenue multiplied by quantity, and that gives you the total profit. 461 00:39:57.700 --> 00:40:01.700 Any questions on this? 462 00:40:01.700 --> 00:40:07.700 This is the high-powered stuff of the month, yeah. 463 00:40:07.700 --> 00:40:18.700 Given that you're operating altogether, as I say, you can see that for a certain wide you go out of business, this would be the minimum loss area. 464 00:40:18.700 --> 00:40:30.700 All of this is loss because average cost is always above average revenue in this particular diagram, so this is the minimal point, given that you're operating at all. 465 00:40:30.700 --> 00:41:00.700 So, and given a one peak curve, a one peak total revenue curve, if it's two peaks then all the bets are off, you have to look for the, you know, you have to look for the expected total, but as I say in the textbook they never talk about two peaks because that screws up the whole math and the whole geometry of it screwed up. You can't rely on tangents and all the rest of the things. Okay, let's take a ten minute break and get on the applications here of this analysis, maximum profits thing. 466 00:41:00.700 --> 00:41:09.820 Supposing you're a business firm, you're here, you're producing this much, you're 467 00:41:09.820 --> 00:41:16.780 in the inelastic demand curve zone, in other words, okay, so you're in this kind of a 468 00:41:16.780 --> 00:41:23.460 situation, price and quantity, so that means that you're in a situation where you cut 469 00:41:23.460 --> 00:41:29.740 your production, let's say this is 1500 units, you cut your production from 1500 to less 470 00:41:29.740 --> 00:41:41.600 The total revenue goes up because you're in an elastic demand curve for the firm. 471 00:41:41.600 --> 00:41:42.600 Therefore you will do it. 472 00:41:42.600 --> 00:41:46.980 If a business man has any smarts at all, he will get the hell out of this situation because 473 00:41:46.980 --> 00:41:48.140 all he has to do is to cut production. 474 00:41:48.140 --> 00:41:52.140 When he cuts production, the total cost goes down, the total revenue goes up and he automatically 475 00:41:52.140 --> 00:41:54.740 makes more money. 476 00:41:54.740 --> 00:41:59.340 For a no-business firm which has any smarts at all will ever remain in this zone. 477 00:41:59.340 --> 00:42:05.340 In other words, it will always be in this zone here, even if it doesn't quite hit the 478 00:42:05.340 --> 00:42:10.020 maximum profit point, which is difficult to do, because you don't always know what your 479 00:42:10.020 --> 00:42:15.060 demand curve is and what your cost curve is, if you see it all, all you have to do is to 480 00:42:15.060 --> 00:42:19.180 cut costs and your total revenue goes up, you will do it. 481 00:42:19.180 --> 00:42:24.420 So the conclusion is that every firm, every business firm will always be, will always produce 482 00:42:24.420 --> 00:42:26.940 in an area where the demand curve is elastic. 483 00:42:26.940 --> 00:42:33.620 In other words, this area here, this is the rising total revenue curve, the elastic demand 484 00:42:33.620 --> 00:42:36.620 curve zone. 485 00:42:36.620 --> 00:42:40.020 So that means every firm will have an elastic demand curve, because if they're in an elastic 486 00:42:40.020 --> 00:42:42.060 zone, they'll get out of it, they'll cut production quickly. 487 00:42:42.060 --> 00:42:44.820 The reason why they'll cut production is not to increase it, because it's very easy to 488 00:42:44.820 --> 00:42:45.820 cut production. 489 00:42:45.820 --> 00:42:50.820 If you cut production, the costs are lower and your total revenue is up, you will do it. 490 00:42:50.820 --> 00:42:55.820 So, this area is not viable. No firm will be in it. 491 00:42:55.820 --> 00:43:01.820 We have a very important conclusion here. The conclusion is that every firm will have an elastic demand curve. 492 00:43:01.820 --> 00:43:06.820 It will be in an area where the demand curve is elastic. 493 00:43:06.820 --> 00:43:12.820 We've already seen that the demand curve for the firm is more elastic than the demand curve for the industry as a whole. 494 00:43:12.820 --> 00:43:16.620 because you have more range of choice for the consumer, Wonder Bread, Pepperidge Farm, 495 00:43:16.620 --> 00:43:19.700 whatever, there's much more range of choice than bread, period. 496 00:43:19.700 --> 00:43:21.340 But now we see more than that. 497 00:43:21.340 --> 00:43:25.060 Not only will the man curve for the firm be more elastic than the man curve for the industry, 498 00:43:25.060 --> 00:43:26.060 it will be elastic, period. 499 00:43:26.060 --> 00:43:32.500 In other words, we'll be in a zone where if you increase production, cut prices, the total 500 00:43:32.500 --> 00:43:36.700 revenue goes up, you raise prices, the total revenue will fall, the firm will always be 501 00:43:36.700 --> 00:43:37.700 in this zone. 502 00:43:37.700 --> 00:43:40.980 Because if the firm is in this zone, we're talking about a firm now, not an industry. 503 00:43:40.980 --> 00:43:45.580 The firm will never be in this zone because it will always be immediately profitable to 504 00:43:45.580 --> 00:43:49.500 cut production, cut costs and raise revenue. 505 00:43:49.500 --> 00:43:53.120 No firm will, given any smarts at all, get me in a situation where I'm losing money by 506 00:43:53.120 --> 00:43:54.660 producing more. 507 00:43:54.660 --> 00:44:01.740 So every firm will have an elastic demand curve. 508 00:44:01.740 --> 00:44:09.620 Now this really covers the theory of costs and demand. 509 00:44:09.620 --> 00:44:14.180 We now get to the whole area of monopoly and competition, and the, I'm going to say it's 510 00:44:14.180 --> 00:44:18.100 going to be much shorter than the stuff in the book, we have to deal with some case studies 511 00:44:18.100 --> 00:44:26.300 of course, but basically, the problem with textbook microeconomics is in the 1930s they 512 00:44:26.300 --> 00:44:32.700 erected a so-called ideal, which they've been getting away from ever since, I mean the micro 513 00:44:32.700 --> 00:44:35.700 texts are much better now than they were 50 years ago, they still have not thrown over 514 00:44:35.700 --> 00:45:04.700 According to the theory of so-called perfect or pure competition, notice the name is perfect 515 00:45:04.700 --> 00:45:10.580 Perfect and Pure, a value-loaded terminology, although the economists claim to be value-free 516 00:45:10.580 --> 00:45:13.320 and non-emotive. 517 00:45:13.320 --> 00:45:14.320 Perfect sounds good. 518 00:45:14.320 --> 00:45:19.700 If you say a situation is perfect or pure, it implies that it's a good situation. 519 00:45:19.700 --> 00:45:24.040 It's better to be perfect than imperfect, it's better to be pure than impure. 520 00:45:24.040 --> 00:45:29.140 Perfect competition or pure competition is defined as a situation where the man care 521 00:45:29.140 --> 00:45:36.820 Whether the man curve for the firm is horizontal. 522 00:45:36.820 --> 00:45:41.460 Instead of being simply elastic, whether the man curve for the firm is perfectly elastic 523 00:45:41.460 --> 00:45:46.220 or infinitely elastic, that's supposed to be the best situation. 524 00:45:46.220 --> 00:45:49.220 Why it's the best, we'll go into a little later. 525 00:45:49.220 --> 00:45:54.660 To say it's unrealistic is putting it mildly, because it never exists. 526 00:45:54.660 --> 00:45:59.980 What it implies is that, regardless of how much the firm produces, it won't have to 527 00:45:59.980 --> 00:46:00.980 cut price. 528 00:46:00.980 --> 00:46:02.740 We've already seen the mangroves are always falling. 529 00:46:02.740 --> 00:46:04.420 How can it be horizontal? 530 00:46:04.420 --> 00:46:09.460 The theory is, it's true that the mangrove of the industry is falling, but if each firm 531 00:46:09.460 --> 00:46:15.380 is very, very tiny, say the wheat market is a classification of a big wheat industry, 532 00:46:15.380 --> 00:46:20.260 each farm is only 100 acres or 10 acres, if Hiram Jones, wheat farmer in Iowa, increases 533 00:46:20.260 --> 00:46:23.580 the production by 10%, it's not going to affect the entire wheat market. 534 00:46:23.580 --> 00:46:29.980 On that basis, they claim that the demand curve for each farmer is horizontal, and that's 535 00:46:29.980 --> 00:46:30.980 certainly elastic. 536 00:46:30.980 --> 00:46:35.260 It's not really, because obviously, the angel Gabriel came to Hiram Jones and said, look, 537 00:46:35.260 --> 00:46:38.780 I can magically increase your production by a million fold, it will affect his demand 538 00:46:38.780 --> 00:46:39.780 curve. 539 00:46:39.780 --> 00:46:42.420 I mean, he'll have to cut the price in order to sell it. 540 00:46:42.420 --> 00:46:46.660 As a given production, it's very tiny compared to the rest of the industry, does not improve 541 00:46:46.660 --> 00:46:52.020 a product, as a product is fixed forever, doesn't compete in any other spectacular way. 542 00:46:52.020 --> 00:46:56.020 In that situation, the man curve would almost look like it's infinitely horizontal. 543 00:46:56.020 --> 00:46:57.020 Why is that better? 544 00:46:57.020 --> 00:46:58.020 Who knows? 545 00:46:58.020 --> 00:47:00.940 There's certain alleged reasons for it that I think are all phony, but anyway, this is 546 00:47:00.940 --> 00:47:06.340 supposed to be the ideal situation, a situation where competition is perfect. 547 00:47:06.340 --> 00:47:07.340 Anything else? 548 00:47:07.340 --> 00:47:11.580 In other words, in real life, where all the man curves are falling, even for Hiram Jones, 549 00:47:11.580 --> 00:47:16.460 certainly for everybody else, every other firm, because if the firm increases, if it 550 00:47:16.460 --> 00:47:20.860 doubles its production, it'll have to cut the price in order to sell it, it faces a 551 00:47:20.860 --> 00:47:30.220 All real life situations are attacked as being, quote, imperfect or impure or monopolistic. 552 00:47:30.220 --> 00:47:37.020 So the theory of monopoly we've inherited from the 1930s is this very weird theory where 553 00:47:37.020 --> 00:47:41.780 the only real competition, the only perfect competition, is when each firm faces a horizontal 554 00:47:41.780 --> 00:47:45.300 man curve, it says each firm a reality, including ourselves. 555 00:47:45.300 --> 00:47:49.540 I mean, if you go in there, if you become an engineer and you charge your wage rate 556 00:47:49.540 --> 00:47:57.540 You will face a falling demand curve. In other words, if you insist on tripling your salary, you're going to get a much lower demand for your services. 557 00:47:57.540 --> 00:48:03.540 So everybody is a, quote, monopolist in that sense, or monopolistic. All life is monopolistic. 558 00:48:03.540 --> 00:48:10.540 It's a very peculiar kind of terminology, you see, where everybody becomes a monopolist by definition. 559 00:48:10.540 --> 00:48:17.540 So real life, when every firm or every individual or whatever faces a falling demand curve, it's called monopolistic, imperfect and pure. 560 00:48:17.540 --> 00:48:22.540 Perfect and Pure. Notice, these economists claim to be value-free. They're scientists. 561 00:48:22.540 --> 00:48:26.220 They're not passing moral judgments. But look at the moral judgment that's implicit in this. 562 00:48:26.220 --> 00:48:31.860 On one hand, you have perfect and pure and, quote, competitive. And on the other hand, 563 00:48:31.860 --> 00:48:37.700 you have imperfect, impure, and monopolistic. Obviously, value-loaded terminology. Attacking 564 00:48:37.700 --> 00:48:46.220 this as being somehow evil. And the antitrust system, from the 1930s until about 20 years 565 00:48:46.220 --> 00:48:52.300 was designed to try to force industry into this percussive bed of being pure, perfect, 566 00:48:52.300 --> 00:48:54.020 and where every firm faces a horizontal macro. 567 00:48:54.020 --> 00:48:57.220 Remember, it's a break-up industry, you have tiny little firms. 568 00:48:57.220 --> 00:49:04.660 At any rate, this is, say the least, not only is it unrealistic, there's no reason to consider 569 00:49:04.660 --> 00:49:05.660 this is better. 570 00:49:05.660 --> 00:49:09.740 Matter of fact, it's worse to have pure competition than have so-called impure because the situation 571 00:49:09.740 --> 00:49:13.940 every firm faces is so tiny, it's going to be almost horizontal macro, it's going to 572 00:49:13.940 --> 00:49:21.940 I mean, one where every firm is so small, you're not going to tap economies of large-scale production. It would be very costly for the consumer and for everybody else. 573 00:49:21.940 --> 00:49:29.940 But anyway, that's the whole schtick. The whole theory of monopoly is, and all the other terms, oligopoly, monopoly, imperfect, it's all the same thing. 574 00:49:29.940 --> 00:49:33.940 It all means that a firm is facing a falling demand curve. 575 00:49:33.940 --> 00:49:39.940 And notice what's happened here. What's happened here is that originally the terms of monopoly and competition, both in economics and in real life, 576 00:49:39.940 --> 00:49:46.140 were defined very differently up until 30 years ago, 50 years ago. Competition meant 577 00:49:46.140 --> 00:49:51.060 rivalry, it meant people competing for business services, it meant other people, other firms 578 00:49:51.060 --> 00:49:55.640 coming in and competing, or other people coming in. That's what competition meant. Monopoly 579 00:49:55.640 --> 00:50:01.900 meant government grants of exclusive privilege to one or more firms. As I've already talked 580 00:50:01.900 --> 00:50:07.220 about, I'll talk more about now, when the government says only the yellow cap company, 581 00:50:07.220 --> 00:50:23.540 The government grants exclusive privileges to one person or few people or whatever, keeping 582 00:50:23.540 --> 00:50:25.020 out all other competitors. 583 00:50:25.020 --> 00:50:26.020 That's monopoly. 584 00:50:26.020 --> 00:50:30.540 That's what monopoly has always meant, until 50 years ago. 585 00:50:30.540 --> 00:50:33.660 Then the economists come along and they change the definition, and everybody's against monopoly 586 00:50:33.660 --> 00:50:34.660 for good reasons. 587 00:50:34.660 --> 00:50:45.660 Because monopoly means, first of all, you're screwing the consumer, you're taking, you're restricting entry into a firm, into a taxi industry or the medical profession or whatever, 588 00:50:45.660 --> 00:50:50.660 and you're deliberately then, by restricting entry, you're raising the price that the consumer has to pay and cutting the production. 589 00:50:50.660 --> 00:50:57.660 And naturally, consumers are against it if they know what's going on, and competitors are against it. Those are excluded from this global racket. 590 00:50:57.660 --> 00:51:08.660 And so the American Revolution, for example, is a revolution against monopolies, against the British East India Tea Company, given the monopoly of import of tea into the United States. 591 00:51:08.660 --> 00:51:20.660 So, and most of the early state governments had a constitutional clause in the state constitution against monopolies, and that didn't mean facing a falling demand curve. 592 00:51:20.660 --> 00:51:25.500 The Falling Demand Curve, it meant that the government may not grant exclusive privileges 593 00:51:25.500 --> 00:51:31.060 to produce or sell any particular product, they can't say only three guys can produce 594 00:51:31.060 --> 00:51:37.700 salt or whatever, so this is for good reason why most of the people are against monopoly 595 00:51:37.700 --> 00:51:40.460 and then what these people, the economists did was they changed the definition of the 596 00:51:40.460 --> 00:51:46.380 term monopoly to mean not grant a privilege by the government but facing a falling demand 597 00:51:46.380 --> 00:51:50.020 curve which everybody faces, it means everybody is an evil monopolist you see and this changes 598 00:51:50.020 --> 00:51:52.940 is the whole meaning of the discussion. 599 00:51:52.940 --> 00:51:56.660 Competition became not competing for products 600 00:51:56.660 --> 00:51:59.100 or making better products or making it cheaper or whatever. 601 00:51:59.100 --> 00:52:01.460 Competition meant a horizontal man curve. 602 00:52:01.460 --> 00:52:03.740 It meant not being able to affect your price 603 00:52:03.740 --> 00:52:04.980 regardless of how much production you make. 604 00:52:04.980 --> 00:52:06.580 It's very weird, and yet this conquer 605 00:52:06.580 --> 00:52:08.940 of the economics profession, at the same time 606 00:52:08.940 --> 00:52:11.220 when Keynesianism and macroeconomics also conquered it, 607 00:52:11.220 --> 00:52:13.700 and it took about 50 years to get rid of Keynesianism 608 00:52:13.700 --> 00:52:16.300 or to roll it back, it's taken about the same amount 609 00:52:16.300 --> 00:52:19.060 of time to roll back the perfect competition doctrine. 610 00:52:19.060 --> 00:52:22.960 It's been rolled back a lot in the last fifty years, but not enough, of course. 611 00:52:22.960 --> 00:52:25.840 Anyway, I'll now hand out the papers, the exams, 612 00:52:25.840 --> 00:52:27.220 shift to that. 613 00:52:27.220 --> 00:52:29.500 You all did spectacularly well, almost too well.