Mid-Term Review and The Theory of the Firm

0:00Midterm 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. Okay, we've done the first two parts of the course on demand and supply and price and applications and key studies of government intervention into the PICE system. We started with the law of diminishing marginal utility, in other words, given this is utility on the y-axis, and this is quantity, the greater the supply of the good, the lower the utility of each unit.

0:52That's the lower dimension of marginal utility. So that if you, this solves the value paradox, in other words, the idea how come that, how come that water, even though it's extremely important for life, or bread, which is important for life, is very cheap. On the other hand, diamonds, which are a mere luxury and frippery, are very expensive. That's the famous value paradox, solved by concentrating on the unit. In other words, that the people do not evaluate the entire supply of bread or water or diamonds for all time or even for the current time, they evaluate each unit, each loaf of bread, each carat of diamonds, each glass of water or gallon or whatever, and this solves the value of paradox because there's a lot more bread and water around than there are diamonds and so the relative scarcity of diamonds is greater, unit, in other words, lower marginal and Utility. Margin concentrates or focuses on each unit, and utility means value placed on a unit. So this means, as I say, the greater the supply, the lower the value of each unit.

2:19We don't know the exact slope of this. As a matter of fact, you can't even talk about the slope, since this value is an ordinal concept, utility is an ordinal concept. But We do know that it's lower as you get more units of a good. Taking that and also taking into account every individual in the market has different value scales and different valuations that he or she places on different commodities, you wind up with a falling demand curve. In other words, the price of any good or service on the y-axis, quantity on the x-axis and Any given price, at a higher price, people will buy less of it, at a lower price they'll buy more of it, you get something like that. We don't know that it's linear, we just know that it's falling, in that sense it's a little bit like a utility curve there.

3:11Just for convenience we make it a straight line, but all we know is people will buy more of it at a lower price and less of it at a higher price, that's the key, and by knowing Considering that, you already know more than most of the people in the United States, because most people think that the man curve, think of it as vertical, and regardless of what the price is, people buy the same amount. You know, they and their daily lives, of course, don't act that way. So we have a falling demand curve, and the major property of the demand curve is elasticity. 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.

3:57Less 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? If it only increases a little bit, the man curve is sort of inelastic. If it increases a lot, it's sort of elastic. 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. The man curve cannot be horizontal because it's falling at any given price, and it can't be vertical for the same reason. Any demand curve will be within this structure. You can define elasticity in various ways.

4:44The textbook definition is alright for its own purposes. Elasticity is the percentage change in quantity divided by percentage change in price. That's one way to do it. The trouble with that is, there's nothing wrong with it mathematically, It's irrelevant economically. Nobody really measures this thing because nobody knows what it is anyway. And from an economic point of view, from the point of view of the business man, the firm or the industry, what's really important is the direction. What happens to total revenue? That's what it's really concerned with. If you cut price, will total revenue go up or go down? It could work either way, since total revenue is equal to price times quantity, as the price falls, these two things are going in opposite directions. In other words, as the price goes down, quantity goes up. And what the impact on total revenue is purely depends on the problem, depends on the good and the people buying it and all that sort of stuff.

5:36Nobody knows in advance what it is, they can have hunches, but nobody knows any precision what the elasticity of the man curve is at any time. So the way I define elasticity is the man curve is elastic if when price change, when When price falls, total revenue goes up. So this total revenue, this area here, which is twice times quantity, is greater than this. So the man curve is elastic if when price falls, price falls, total revenue increases. and demand curve is inelastic if when price falls, total revenue drops, so this would be elastic, and this would be inelastic, and it's inelastic if when price falls, total If the total revenue remains the same, in other words, if it's some online here, then it's called unitarily elasticity, unit elasticity.

6:55So this is unit, or elasticity equal to one. If price falls, total revenue remains the same. 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. 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. If, on the other hand, it only goes up to $105, then it's $945. In that case, total revenue is inelastic.

7:50If 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. Neither elastic nor inelastic. And we saw that the demand curves as they were drawn by economic textbooks, in economic textbooks, before 1943 approximately, were all like this, they were rectangular hyperbole, which means that the total revenue was always constant, never changed. And the way this got out of the textbook, it takes a lot to get something out of a textbook, once it's enshrined in a textbook, it takes almost dynamite to get it out. And Professor Stiegler, a later Nobel Prize winner in economics, said, well, why do they say this?

8:35There's no evidence for this nonsense. There's no evidence that total revenue remains the same. In fact, it probably changes. Why don't we make it a straight line? Ever since then, the man curves have been straight line. There's no evidence for that either, but at least it doesn't assume constant total revenue. At least you can see that there are changes that go up and down. So this is the most important property of the man curve, it's elasticity. And that depends whether total revenue goes up or down when the price changes. Of course, the exact opposite occurs when you go up and the price increases. In other words, in economics and microeconomics, it always changes the signs, so it's symmetrical. So this is, if the price goes up, elasticity, if the price increases, total revenue drops full. The exact opposite happens, you go up, in other words, you go up from here, price goes 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.

9:30So again, you just reverse this. So if the price increases, the total revenue increases, then it's an inelastic demand curve. And similarly, of course, if the price increases and the total revenue remains the same, you still have your unit elastic range. 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. 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. 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. 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.

10:26Okay, 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. Oh, one thing about the elasticity of the man, again, is that, you know, we don't know what the elasticity is. 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. 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. The other hand, if all the bread prices go up, there'll be a falling off and not nearly as great because there won't be that range of choice. Consumers wouldn't be able to shift from Wonder Bread to Tasty Bread or Pepperidge Fond, they're all going up.

11:16You have to shift the rolls or whatever. So similarly here, if Wonder Bread is the only firm that cuts its price, you have a big increase in quantity purchased. If all the breads cut their prices, you'd have a small increase, not nearly as much. So the other thing we can say is that a man curve for the firm, the individual firm, is always greater than a man curve for the industry. Could be a little bit greater, could be a lot greater, we don't know, but we do know it will be more elastic, man curve for the firm, unless of course the industry has only one firm in it, it will become the same thing. So alright, then we move from that to the determination of price, the most important single item, single part of a course. How are prices in the market determined? In the market, of course, you have exchange of two commodities and two people. And every exchange is that sort of exchange. I'd buy a sandwich for whatever it is, a buck and a half or something.

12:13I'm exchanging a buck and a half for a sandwich. So this is price again on the y-axis, quantity x-axis. You have a demand curve for any given product, a fully demand curve, and you have 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. 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. 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. and this will be the equilibrium price, any good or service. If the good or service differs from that, differs from the equilibrium, the forces of the market will immediately bring it back to that particular intersection point. That's why it's called equilibrium, because equilibrium physics is something that tends to rest at a certain point. If it's displaced

13:13from that point, it goes right back to it. Similarly, market forces bring it right back to the equilibrium point, market forces in this case being two things, one is a free price system, in other words, the price system is free to move, and two, desire a businessman to make profits and avoid losses, that's all you need, of course, all businessmen have that desire, otherwise, it wouldn't be a business very long, if they don't desire to avoid losses, for example, they'll lose a lot of money and be out of business. So then we saw that if the price, for example, is higher than the equilibrium point, then There will be a certain amount ready to be sold, much less of it, sellable to consumers. This will be an unsold surplus, which will pile up on a shelf, something which all businessmen hate like they're very dickens, like blazes, stuff they thought was going to sell and so it's piling up unsold.

14:03And then they find as they lower the price of it, lo and behold, more will be sold, so finally as they keep lowering it, surplus is over. So the way the market eliminates unsold surpluses by cutting the price as the price falls is to go back to the equilibrium point. 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. At that lower price, they want to buy this much. And this is a shortage. In other words, here you have an excess demand. Your demand is greater than supply at that price. shortage means that stuff disappears from the shelves and breaks rapidly and then businessmen say, hey, this means I can raise the price without worrying about cutting sales and as they raise the price the shortage becomes more and more over so finally you're back to the equilibrium point, no shortage and no surplus

14:53so below the equilibrium price demand is greater than supply, excess demand, above it, supply is greater than demand in other words, excess supply or surplus, only at this price What is this price, is the demand and supply equal, in other words, it's called clearing the market, where supply and demand are exactly equal, as much, as sold as the people want to sell. In other words, businessmen produce a certain amount, they want to sell it, and this is exactly the amount that the consumer is willing to buy. So this is the price which would be set to determine the market. This is, in other words, one of the great, one of the important things that shows this, that even though people who don't understand economics think that the market is chaotic, The prices are cat. Nobody knows why prices are set the way they are. It's all unplanned.

15:38There's no government planning board which says, okay, you and you produce this much and sell at that price. Instead of that, it works much better than government planning because it works smoothly and integrates and harmonizes the amount people want to pay for a product with the amount that people produce. It equates supply and demand. So every step of the way, either in consumer goods or producer's goods or raw materials or like mining coal, or whatever it is, there's never any shortage or any surplus. There's always an equation of demand and supply. 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. That's why Adam Smith says the market works as if there's an invisible hand harmonizing everything. It doesn't mean there isn't an invisible hand, it just means that's the way it works.

16:25Okay, if the price tends to be set at this particular point, what can change it then? If there's an equilibrium price, why do prices change all the time? And the answer there is, of course, that either supply changes or demand curve changes. Those are the only two things that can change prices. We'll see later on. A cost, an increase in cost, cannot increase price. It only does it through cutting supply, because these are the only two factors that go into a price determining price. 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. And, in other words, you then have a big drop in supply, supply curve shifts to the left.

17:14It means that the old equilibrium price is now a shortage, demand is not greater than supply. Prices therefore go up, you wind up with an old equilibrium price, a higher price, which clears the market. So, a decrease in supply, a decrease in supply of X, means an increase in price of X. This shows how prices perform a rationing function. Prices perform two important functions. One is a rationing function, rationing the scarcity. If the scarcity is greater, price goes up. If the scarcity is less, the price is cheaper, down to the point where if goods are super abundant, like air, then the price is free. You don't have to worry about it, it's always there. So the greater the... Do you have a question? No. The greater the The results of scarcity are greater than the price.

18:04Conversely, if the coffee crop is finally adjusted, however, it comes back in a normal situation, then you have an increase in the supply. At the old equilibrium price, you don't have a surplus. In order to induce people to buy more of the coffee, you have to lower the price. As the price is lowered, you eliminate the surplus, you wind up with a new equilibrium and the Rationing price, where the supply is greater and the price is lower. In other words, scarcity is less now, and therefore the rationing thing becomes less intense. An increase in the supply leads to a drop in price.

18:44Now, over time, most goods in a free market economy, goods tend to increase as you have increased capital investment and better technology. Most goods, supply tends to increase, so prices tend to fall. In other words, the general trend is of falling prices. You can see that dramatically in areas where you have tremendous increase in productivity. A few years, computers, calculators, TV sets, things like that, where prices are falling even though you have a general inflation, a teak of general inflation, which means the real prices, in other words, prices in terms of the price level of the whole, are falling even more than you might think. And if you consider per unit quality, which is the way you really have to think of prices, because a good is homogeneous, remember if we define a good as n homogeneous units, supply of a good, sorry, which means that n homogeneous units, so in order to be really homogeneous you have to have the same quality.

19:44Usually in the market economy the quality improves all the time, matter of fact, except 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, So the quality goes down with government. So that's the supply side of the situation.

20:29If you ask the question, if prices are always tending to go down, how come prices are always going up in general, the answer is the macro course. You learn that next term or whatever, because government keeps pouring more money into the system. In other words, government is like a vast counterfeiter. It's like it is a vast counterfeiter. It just prints money all the time and creates more money. more money. As it creates more money, of course, prices tend to go up. As greater demand, known as demand curves go up, everybody's got more money in their pockets than they had before, which tends to offset the fallen prices due to increased productivity. Okay, so that's the supply side. We now get to demand. What can increase the demand curve? Change the demand curve. And when we talk about demand increasing or decreasing, we mean the entire curve shifting up or down. And again, I'm going to repeat this again for the nth time.

21:14We should not confuse going down or up, given the man curve, with a change in the whole curve. When the supply increases, the price goes down, the quantity demanded goes up. In other words, the quantity produced and sold goes up. The quantity demanded goes up, but the entire demand curve does not go up, it doesn't change. The reason it doesn't change is the man curve is defined as the locus of what happens when prices change. In other words, you have a certain amount at any given price, how much will be purchased. So, if the price falls, unless you say the man curve is going to change, which there's no reason why it should, as the price falls, the quantity of demand that goes up as the man curve as a whole remains constant. The man curve remains constant. You're going down the given the man curve. The only thing which cannot increase the demand curve is the change in price.

22:02The only thing which can't cut the demand curve is the change in price, because the demand curve is defined as response to prices. So in other words, when a man curve goes up, why should a man curve go up? Well, it can go up for many reasons, either because the government prints more money, everybody's got more money in their pocket. One reason to go up. The man curve going up means, technically, at any given price, more will be purchased than before. Whatever the price is, there's an increase in purchases. So if everybody's got more money, if the government prints a lot of money and distributes it around, by spending, by lending it out and ripples through the system, then demand curve will shift upward. Or if there's a big tax cut, let's say, we'll have more money in our pockets, demand curve will shift upward.

22:50That'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. There's all sorts of value changes. It can be important or it could be frivolous. Economists don't worry about that. It's up to moralists and whatever, social psychologists, whatever it is. All we register is the fact that demand curves go up or down. Values change. For example, it used to be that the big game around here, outdoor game, was hula hoops. Big fan of hula hoops one year. And everybody bought hula hoops. Big increase in demand for hula hoops. And then hula hoops dropped out of Frisbee's comment. Big Frisbee boom, which I think is probably still going on in Frisbee. I don't know. I'm not really up on all of this. At any rate, and then of course a couple of years ago came the famous cabbage patch doll caper 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

23:45One guy flew to London to buy it because in London they hadn't had this big cabbage patch doll, boom So he had his weight paid for, I think his wife was a travel agent or something like that, or a steward The still and old is obviously very expensive to schlep the London of my doll for Christmas. It's still going on and the question for the Cabbage Patch doll people is, will this continue? 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. 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, So these are shifts up and down. In some cases, the drop in decreases in the man curve. In other cases, it increases.

24:41So when the man curve increases, there's a rise in price. 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. 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. And so, there's a price fall to induce people to buy the available supply, and the price goes down. Then we get into the fact that as demand changes, if the demand is considered, change is considered fairly permanent, then there will be a change in supply, supply in the long run in response to demand. So in other words, if there's an increase in the demand curve for vodka, then people realize that the vodka makers, okay, we're going to get out of bourbon, out of bourbon, we're going to get into more and more vodka, and as they do that, depending on the technology,

25:34how long this takes, it all depends on the individual item, they'll start increasing 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. So you wind up then with a higher price perhaps and a greater output. 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. Over the years, we have a lower production and a higher price from the original, somewhere in between again. So in this way, consumers over the long run, because we didn't see, first we talked about a given supply line, well then we start talking about what determines the supply line, it's not God given.

26:22It was due to previous decisions by producers, you know, six months ago, a year ago, five years ago, whatever, depending on the good. In the case of liquor or wine, particularly, it takes many years of course of wine to ripen and stuff like that. Anyway, over the long run, then you get in the situation where if an increased demand will then induce a greater supply of the product, a lower demand will cause a lower supply of the product. So in that way, supply, production, response, and consumer demand. And a greater demand will cause greater output and vice versa. Except of course in goods which are output are fixed forever, like Rembrandt paintings. And see, you've got a perfect forgery, which these days of technology is almost impossible because they can date stuff, things like that. Supply of Rembrandt is gone with Rembrandt. It's absolutely fixed. It certainly can't be increased.

27:10Once in a while you can lose a painting or somebody can destroy it, but you cannot increase. So anyway, in that way, supply and the market production responds to consumer demand. First is what people expect consumer demand will be, and then if the producers are right, if demand is increased, then they'll make profits, this will spur them to make even more of them. 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. So in other words, profits and losses are signals to producers whether they're on the right track or not. They make higher profits, they'll increase the production. They make lower profits or losses, then they'll cut back. So the profits are like a signal whether they're on the right track at serving consumers or not.

27:55And 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. Okay, so that sort of covered any given good. Then we went into relationships between goods.

28:25The two major ones are substitutability, co-substitutes, or goods and substitutes for each other fulfilling the same market. Coffee and tea, cocoa and tea, metals, aluminum and steel, all these things can feel more or less the same. not perfect substitutes, but they're fairly close. So what happens, for example, when the supply curve of coffee went down, and coffee became more scarce and more expensive, people shifted more and more to tea and cocoa. So you then have a, as a result of this, an increase in demand curve for tea, let's say, and the price of tea tended to go up, and cocoa the same way.

29:20So we can then say that the decrease in supply of x brings about an increase in price. This increase in price will in turn bring about an increase in demand for y, the substitute, which in turn will raise the price of y. It's separate, separate, you can just change the sign and get the same thing. An increase in supply of x causes a drop in the price of x, causes a drop in the demand 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. Eventually, of course, the output in the long run. Okay, then there's compliments.

30:08A 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. 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. Or factors that go into labor and capital and land go into a certain production. 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. All these things will increase. The prices will go up. Wage rates will go up. Champagne, country, and so forth and so on. So these are joint demands. And one interesting thing there is what happens when the supply changes in one of these factors.

30:59In other words, they say bread and butter for sandwiches. They say bread and butter is only for sandwiches. If the price of butter gets cheaper, spectacularly cheaper because of an increase in productivity or fertilizer or whatever, then the price will fall, increase in supply of X. 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. But bread hasn't gotten cheaper. I mean, bread has the same supply as before, so the price of bread will go up. 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.

31:53Or complements. 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, 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. In both cases, the prices are going in opposite directions here, between the two factors, when the supply is the source of the change. 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. In the case of supply, however, it gets a little trickier. And the other jointness, the other component was joint supply, where two goods are simply produced together and are found together in nature. 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.

32:42And same way with copper and silver which are found together and so forth and so on. 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. In other words, demand for x goes up, increase demand for beef, let's say, and this increases the price, which in turn increases the supply of x in the long run.

33:31And this in turn increases the supply of y, which lowers the price of y. This finishes the relationship between goods and then we talk about what happens when the government interferes in this process, a whole bunch of case studies about that. This can be summed up as either maximum price control or minimum price control. We always talk about cartels a little bit, but that's not going to be after the midterm. In maximum price control, which is more common, a government orders that you can't sell above a certain price, which is below the market equilibrium price.

34:18This is the maximum price control, which puts the price to lower the price below the equilibrium by force. Putting a floor on it, a ceiling on it, excuse me, on preventing it from going up. One of the situations we saw that caused all sorts of problems, the first thing that caused a shortage, it means the shortage cannot be eliminated in the market, you have a permanent shortage which gets worse over time as the supply goes down, there's an unprofitability of the whole product. And then you have black markets, which are very high prices, they're very scarce, they They can't advertise, they have to pay off the cops and all that. You have like a small black market around the edges and a decline in rationing through lining up, so being on a waiting list or standing in line, because this has to be rationed in some way.

35:09If the price system can't ration, it's got to be done through coercion, through ration tickets and or standing in line through favoritism, through the producer taking over racial and religious discrimination because the producer is in the saloon, he doesn't have to worry about customers, there are plenty, there are too many customers and they can ration customers and say, okay, I like this guy and this guy, this guy is my brother-in-law, this guy is not the same race as I am and how about everybody else? So this is, these are all, and also the decline in quality, a hidden price increase is the quality of the crime which cannot be policed, it's almost impossible except for certain visible things, but police the decline in quality, figure out is there really less almonds now than there used to be in the chocolate almond crunch ice cream. So, and of course it doesn't really cure inflation, usually the maximum price of inflation doesn't do that at all, it simply makes things worse.

35:58Inflation is caused by an increase in demand curves due to an increase in money supply, which keeps bubbling more and more merrily anyway. In minimum price control, the government keeps the price above the equilibrium point, free market equilibrium, and this perpetuates a surplus, in other words, instead of the surplus are being eliminated quickly to the price system, but now this is the minimum price on the price floor, perpetuates unsold surplus. In many cases, the surplus gets worse over time because the producer can produce more of it. Hey, the price is pretty good here, and calls for an even greater surplus that the government has to handle in some way. Two big examples of this are the farm price support program, which is a total mess and getting worse, As the surpluses keep piling up, the minimum wage laws create unemployment among the lowest paid workers.

36:49Examples of maximum price control are legion, there's not only things like meat control, World War II, and all sorts of other things, 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, and all sorts of other stuff, rent control which causes housing shortage, apartment shortage and causes all sorts of ways to try to evade the regulations. And all these things are examples of price control that's all in action. That really, I guess, sums up the course. I don't have much time for questions. Any questions on any part of the course? Any other stuff? 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.

37:43I went to Europe. Well, I went to Poland, the conference in Poland and London and toured around the continent a bit. Basically, it was a Polish conference. No, no, our school? Good heavens, no. Just be kidding. No, this was financed from London, organized from London, and so the Polish scholars there all against the government. It was heroic. It was very openly, even though it was probably an apparatchik spy and they didn't care. No, apparently they're very outspoken. There are no Polish intellectuals in favor of the government now. 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.

38:31So 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. Even in Hungary, where they, which is much freer economically, is not as intellectually free. So that was very interesting. 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. 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. At any rate, to return to our mutton theory, we're into the theory of the firm, and the objective of each firm is to maximize their profits, rather than have as high a profit as they can to avoid losses.

39:25Profits are equal to total revenue minus total cost, in other words, over a year period let's 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. If you take in 1.5 million dollars and you pay out 1.0 million, then you have a profit of 500,000. If you unfortunately pay out a million dollars and take in only 0.5, then you have losses of 500,000 dollars. So, everybody is trying to, every business firm, business entity tries to maximize their profits, increase their profits and avoid losses. They can't always do that, losses often pop up, largely because the costs are paid out immediately before the money is taken in, in other words, you have to build your plant, whatever it is, you have to hire your workers, buy raw material, get all the stuff together and then try to sell the product and then try to sell the product at a profit.

40:26So the payout comes now, and the income comes later, and there's also, of course, a big slip here. Consumers don't always do what the, or buyers don't always do what the investors think they're going to do. So they often make losses, and they try, of course, very hard not to. And so this is the, and this goal of trying to maximize profits and avoid losses drives the whole economic free market system, and it equilibrates everything. It equilibrates It's applying to man as we saw on the first part of the course at each step of the way because everybody is trying to increase profits and avoid losses. It's a very simple but effective motivation on the part of a businessman, especially in the fact that the businessman has already paid out the money and doesn't want to lose it. It's a very powerful incentive. There's been questions, not so much about economists, some economists, a small minority, Mostly among intellectual sociologists, people of that ilk, writers, literary types, claiming

41:25that, well, maybe it's true in the 19th century that business firms wanted to maximize profits, but now it's not true anymore. Now the managers have taken over, and managers don't care about profits, so they just want to have a minimal amount. They want to increase the size of their operations, they want a quiet life, etc., etc. Most of this is generally a lot of nonsense. As a matter of fact, it works the other way around. As the corporation gets bigger, there's less and less of the sort of mom and pop kind of motivation. In other words, if you own a grocery store with two employees, your wife might persuade you to hire your incompetent brother-in-law. You know he's incompetent, he's losing money for you, but still in order to keep peace in the family, hire him anyway. So a lot of that goes on in family businesses.

42:11But with a corporation, as the firms get larger and get incorporated, there's much less of There's some of that, of course, but much less of it, because you have to satisfy the stockholders. You haven't got sort of a personal operation anymore. So the drive for maximizing money profits is even stronger in corporations than it is with personal firms. But it's also a drive to keep peace. Private utility takes over. Psychic utility, in some cases, is more important than money profit. Obviously, you can't make losses, because then you go out of business. 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. 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, was called The Modern Corporation of Private Property, a very famous book.

43:08They were neither, well Means, I guess, was sort of an economist, although I sort of questioned it. Burleigh was a corporate lawyer. Their thesis was that in modern corporate firms, the managers are taken over. Stockholders are no longer important. They don't count. 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. Now this I think is refutable fairly easily, it's true that managers often don't care that much about profits, on the other hand, if they don't make profits, if their earning ratio doesn't look too hot, the stockholders first of all get sore, and getting sore doesn't necessarily mean they'll kick them out, it is difficult to kick out managers, you know, there's like a little political machine, the stockholders have to get together and Organizers, there's a lot of them, there's maybe 2 million stockholders in some big corporation.

44:07They don't have to organize. The interesting thing about a corporation is all the stockholders have to do to exert their power is to vote with their pocketbook, in other words, sell the stock. So if you own 10 shares or 100 shares of General Motors stock, you think General Motors is not doing very well, its profits are low, it's... We just sell the stock and buy something else. The act of selling the stock drives down the price of the stock and makes the managers The stockholders are very upset because they don't like the fact that the value of their stock is going down. Also, selling of the stock is sort of a key thing here. So long before the stockholders start organizing to kick out the managers and get somebody else in, they sell the stock and the value of the shares goes down. The managers also own shares. After all, managers get paid partly in shares of a corporation, especially with the income tax the way it is.

44:53They don't have to pay money on the shares of stock. So a top president of a corporation might make $200,000 in salary and $500,000 in shares of stock of a company. So he himself is a stockholder and is worried about, he doesn't like to see the value of the stock going down. So it works in a very quick, smooth fashion. You don't have to have the big dramatic vote. In contrast to that, of course, is government operations. We should always contrast and compare government with private enterprise. enterprise. A government firm, government agency, say the post office, the beloved postal service, or the transportation authority, we can't sell our shares in it, we're supposed to be owners. We the people are alleged owners of a public corporation, we're taxpayers and citizens therefore owners.

45:43We can't sell our share, if we don't like the profile and transit authority, if we don't like the way the rotten subway system is run, we can't sell our shares in it because we ain't got no shares, we can't sell our shares on a rotten postal office either. If we could do that, it would be a very different situation to keep the managers on their toes, but the managers get paid from the taxpayers, they don't care, there's no shareholders to worry about. So shareholders exert an enormous amount of power, even without voting, because voting is just a small part of it. By selling their shares, by the value of the shares going down, they register the signals of the managers, you better shape up, fella, because you're going to lose out. So selling shares of stock is very important. The market every day evaluates and re-evaluates corporations without fear or favor. They don't care about the fact that the guy's been a beloved and he's been a member of the Union

46:30League club, he's been a trench for 30 years. They don't care about that. If the prospects are bad, they start selling their share and the stock's value goes down. Also, of course, in addition to selling the stock, which is the key thing, keeping managers is honest, is the so-called takeover bid, as you see very dramatically, if the share of stock gets low, in other words, if it's basically sound corporation but being badly managed and the value of the share goes way down, this becomes a tempting for takeover bids for other capitalists to say, look, the right letters to the shareholders, say, look, get us in there, we'll take this company, we'll make a big profit out of it, and we To improve our judgment and our capacity for making profits by giving you a much bigger deal than you're getting, better deal than you're getting now, let's say the value of a share of a corporation is $70 a share, we'll pay you $100 a share if you get us in, if

47:29you sell us enough shares so we can take over. This is a powerful incentive, it's also a powerful incentive for the existing managers to shape up and not let the corporation run down and not make profits, otherwise somebody will come in and take over a bid. Interestingly enough, the liberal media, the establishment, so to speak, is always in favor of the managers. Next time you notice about a takeover, they always hate the takeover bidder. The takeover bidder is a corporate raider, he's a pirate. He comes from Texas, which automatically makes him evil. He's despising these beloved managers who have been here for 30 years. Well, that's the whole point of capitalism and the market economy. You're being despised if you're doing a lousy job. and job. And so this is what competition is all about. It's interesting that liberals who tend to be, who propound of the idea that a terrible thing managers are taking over from stockholders, when it gets down to the bone and the stockholders revolt, they're always

48:22in favor of the managers against the stockholders. It's an interesting little item here. Any change in the status quo they consider somehow disrupting and bad in some sense. Of course the managers are there telling the, they are there as the existing managers, the president and whatever corporation is being under a quote, attack unquote from a takeover bid is giving interviews to the New York Times or the Post or whatever it is and CBS and saying, look at the terrible thing, these guys are from Texas and they're evil. Guys from Texas aren't here and established and therefore they don't have the access to the media that the local people do. So there's always a poisoned atmosphere against the newcomers, reinforced often by court decision. Of course the lawyers are in there all the time. Every one of these These guys are fleets of corporate lawyers battling in the courts for years to try to stop takeover bids, to try to facilitate them.

49:14But 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. You don't have to wait for the stockholders themselves to organize and get together. 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. They come in and say, okay, we're going to buy this corporation if we think it's doing a lousy job. and we'll do a lot better. We'll pay the shareholder $30 on a share, which is a powerful incentive. So anyway, through this, through these methods, to take over a business, especially through selling stock, stockholders are effectively the directors or owners of the corporation, not the managers, although the managers get the publicity, of course, on a day-to-day basis. Of course, if I own one share of General Motors, I'm not going to have much of a say I'm not saying each individual is stock hold, except to selling stock as a share, as a

50:06power. So if you have, let's say, 10% of the stock, or a group of people have 10 or 15%, you can basically run it. And of course, if the manager does a lousy job, you might not want to run it anymore. You might want to sell it to somebody else who comes over to take over a bit. So in this way, the stock market works in such a way as to make the market economy as efficient as possible. is profitable and is efficient in serving the consumers as humanly possible, making a manager shape up. It's true that managers do try to finagle from time to time. For example, when you're estimating your profits, during inflation, let's say you have a million dollar machine, you spent a million dollars on it, say 1980, and let's say it's a ten-year Fair Machines, 1990 is going to have to be replaced, Orthodox Accounting Methods, I think I've referred to this in the past here, there's a constant war between accountants and economists,

51:11it's been going on for about 40 years since the modern age of inflation has come down under the way, if you buy a machine for a million dollars, you're supposed to evaluate it on the books at a million dollars, it's called historical cost accounting, and then Even if, in other words, this is what you actually pay for, you paid a million bucks, and then ten years later, if you have to replace it, you depreciate, say, 100,000 a year, so you have a fund of a million dollars to buy another one. So this is all very well if there's no inflation, but if you have a chronic inflation as we've had now since World War II, this is not going to work, this distorts the actual picture of a corporate firm, because let's say prices have doubled in these ten years, which is This is not unusual. Prices in fact have gone up eightfold since 1940, threefold since tripled since 1967, tripled in the last 20 years.

52:01So 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. You need another million to replace it. So that the replacement cost, which is really the important thing, who cares about the historical cost? It's interesting for historians. If it now costs two million dollars because of inflation, it means you're wiping out your capital. capital. In other words, you think you may have big profits which you really haven't. In other words, let's say if you think your profit is five million dollars this year, but it's only because you have to replace a couple of machines and you're reckoning it as a million, but it's really cost too many, it really made very little profits. In other words, there's this profit, you over inflate, you inflate how much profit you make because you don't take into account the increase in capital costs, increase in the cost of and the replacement of machinery.

52:50So ever since inflation started after World War II, economists have been telling accounts, look, this is great if you don't have inflation, it's distorting the whole picture. Accountants are finally beginning to come around after about 40 years to realizing they've got to do something. That's true, it gets sloppy, you see. If you base it as a million, if you paid a million bucks for it, you have a check in 1980 saying, okay, I paid a million dollars for this, this is objective, that's precise. If you're trying to estimate how much inflation is, it's not objective, it's not precise, Tax, as we see in macro courses, it's very imprecise, but still you have to do something because otherwise you're going to be wiped out, your capital investments are going to be wiped out. So as a result, what happens is over the years there's been a connivance between of course accountants who've been largely in the 19th century accounting methods, pre-inflationary accounting methods, the government, the IRS, which always wants to have tax more, if you

53:40think there's higher profits it means the government can tax it away, and managers who Managers like to fool their stockholders into thinking their profits are high. Managers don't like to tell their stockholders, it looks like their high profits has really been eaten away by inflation. It's been sort of a conspiracy for many years of accountants, top managers in the government, each one trying to bolster the old accounting system. But as I say, after about 30 or 40 years, finally it's begun to sunk in. It's more or less shifting now toward a more rational accounting system. 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.

54:25Of course, Brilliant Means didn't talk about that. The places, again, where the managers really take over is across the government, there's almost no check at all. 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. There's also another, there's a famous attack on the idea of maximizing profits, the so-called questionnaire method. These are sociologists who go around the businessman, they go to say the president and the chairman of the board are saying Is it your goal, Sarah, to maximize profits? Of course they're going to say no, I mean, it sounds terrible.

55:11No, 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? 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. 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. What he said was, look, what you ask a businessman is this, you don't ask him, are you in favor of maximizing your profits? You say, Sarah, looking back on your decisions that you made last year, all your business decisions, is there any one decision where you deliberately avoided making profits, where you said, no, I'll take a cut in profits? A businessman always says, why should I do that?

55:54Why should I do a crazy thing like that? Of course not. In other words, you take the marginal approach, you break it down into marginal units. In each of these 50 decisions that you've made, in each one you try to increase your profit as much as you could on that, make as much profit as you could and not try to cut your profit. And then, of course, conceding the fact that your goal is to maximize profits. So it depends on the way you put it, you put it in the sense of looking at each decision, what did you do? And you get a rational answer, of course, that's basically it, you don't get a guff about the public welfare in your country and stuff like that. So in any rate, the goal of each physics firm is to increase your profits as much as you can and to avoid losses. Total revenue, first of all we start, oh I should say, I was going to bring in the readings, read the stuff, does anybody have the book here, Miller book,

56:51the next set of readings I think I have it on the syllabus, if anybody has seen the syllabus, It's the, I think chapter 9, I'll tell you next time, I have it in my briefcase, it's the chapter I'm, oh, ah, thank you, great, it's, yeah, this is chapter, this is part 3, chapters 4, 9, 10, 12 and 14, it gets to the, well, at this point, up until this point I've been more or less agreeing with the book, except I don't have a lot of stuff the book from now on it gets to be much more divergent, although Miller is better than most other books on this topic. People who write textbooks are mired in tradition, they have to present a certain apparatus even though they don't agree with it, at least they feel they do.

57:42So I'm going to take a much shorter and more common sense of view of this whole situation. 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. 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. If you're a business firm, you're making a certain product, whatever it is. If you don't sell anything, you're not going to get anything, you're not going to get any income.

58:27So you start with zip, start at the point of origin. If I sell zero steel bars, I get zero revenue from it.

58:39The total revenue, as we've seen up until now in the course, 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. 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. Well, if you have, if the price is full, here's quantity and price. These are two basic diagrams. The old diagram we're familiar with, price on the y-axis, quantity on the x-axis. And this is the new one, dollars on the y-axis and quantity on the x-axis. Here's a business firm that's making whatever it is, widgets. If it makes a certain amount, it sells at a certain price, and this is the point here. If it lowers the price and increases the quantity Here, total revenue will change, whatever it is. If it's elastic, in other words, if

59:42the total revenue goes up as the price falls, this is fairly flat, then we depict it on this diagram, quantity increases from here to here, total revenue goes up. Obviously, it has to go up from zero anyway, right? It can't get lower than zero. So total revenue, We start with a rising total revenue curve, this is TR, as quantity increases, it keeps going up to a certain extent, whatever, it finally gets to the point, let's say, as quantity increases where total revenue falls, it becomes inelastic at a certain zone, and when that happens, you have a dip, in other words, it reaches a peak, total revenue now falls.

1:00:33This part of the curve is the elastic demand curve zone, by definition. In other words, when the quantity increases, price goes up, and total revenue increases, that means it's the elastic. When the total revenue declines when the price, when the quantity goes up and the price falls, it means it's inelastic. This is the inelastic zone. Now the textbooks all have, this is their curve. They have a one peak curve. It doesn't have to be one peak. God is not, not the creed has to be one peak. It's not going up again. It could 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. In this case, this would be elastic again, and this would be inelastic after this. 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, 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,

1:01:55It'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. 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. The firms love defense contracts because they can get a guaranteed profit of the cost plus rate. In other words, government tells you, look, whatever your costs are, we will pay you back plus 8% profit or whatever it is. It's not the percentage that counts, it's the fact that the cost of profit is guaranteed. So if the cost, if the government will reimburse everybody's costs, what the hell, let it rip.

1:02:45Have beautiful offices, it's very easy to increase costs, it's a pleasure, it's tough You have to cut costs, it's very difficult. You start paying high salaries, you hire a lot of engineers. You notice, for example, that the defense contract advertisers for engineers are much bigger than non-defense firms because their advertising costs are repaid by the government. What the hell? The government pays your advertising costs for engineers. Letter gets full-page ads on the Wall Street Journal, New York Times. Engineers come to glorious California, okay? If you're a private firm which has to make it on the free market, and you can't afford to do that, you have to be more modest. 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. Of course, what's reasonable is very elastic, it depends on whether you're the buddy of the guy in the fence department.

1:03:34Usually you are, and so the whole thing is very cozy and the costs tend to escalate like that. That's why you have the $6,000 coffee machines and sort of stuff. 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. Uncle Sapp, the taxpayer, that's us, pays the bill, therefore it goes skyrocketing. This cost curve in the textbook is only when the firm is trying desperately to cut costs, it was to avoid losses. It was to keep the total cost at a minimum, as low as possible, so that they'll make profits. So this cost curve is the envelope, the minimum envelope of an array of possible costs.

1:04:22In other words, it's the lowest cost in any given quantity produced. And the reason why business firms will operate at the lowest cost is because of their economic interest to do so, 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. 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. skyrocket, $5,000 coffee machines and $20 nails and that sort of, it can be almost anything. So that's one thing, we have a minimum, it's a minimum envelope of possible costs. The other thing is, the next point of dispute here is, my contention is if you don't make any widgets, I'm not a widget manufacturer, I make zero widgets per year, zero steel bars, 0 stereo set, therefore my costs are 0, and this is saying it's fixed cost, it's all baloney, in other words, you start again at the point of origin, 0 quantity, 0 cost, and it's true

1:05:24that there are different kinds of indivisibility that we'll get into later in costs, you build a plant, you have a fixed cost of operation, you don't produce any widgets, but you don't have to have a plant, you can sell a man plant, you can get out, you can shut it down, you They don't have to have fixed costs, there's no such thing as fixed costs, they're all different degrees of variability. So you can toss out all this fixed variable stuff, which unfortunately is of the harder, much microeconomic textbooks, and what you've got really is this, you have total costs which start at a total cost curve, the minimum and lowest envelope of possible costs, any given quantity, and start at the point of origin, total cost zip. And my contention is, which I now have to prove, is that total costs always go up.

1:06:13In other words, that total costs always increase as quantity increases. So this is not self-evident. As a matter of fact, many people think, well, gee, it's not true. Aren't there costs of large-scale production? Don't the cost curve go down? Not total costs, however. Average costs go down, as we'll see. Total costs keep going up. going up. And this can be proven logically. In other words, while total revenue can either go up or down, depending on, because there are two forces at work, remember with total revenue, there's prices and there's quantity, each going in different directions. Price goes down, quantity goes up. And there's a tug of war to see what happens with total revenue. It can either go up or down. Total costs are, on the other hand, always going up. Let's prove it by reductio ad absurdum. That's the easiest way to demonstrate this.

1:07:02In other words, to show that anything else is illogical and absurd. Let's take, this is quantity produced total cost. 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. Let's assume it's minimum total cost. Remember, this is minimum, the lowest envelope. The minimum total cost is, I don't know, $5,000. It doesn't matter what it is. Now the firm makes another unit and increases its quantity to say 101. 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.

1:07:48It's largely impossible for this reason. If your minimum total cost is $5,000 for making 100, 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, But, if you say that, look, I'm saying this is impossible for this reason, demonstrated this way. 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, and you're left then with, but this is 4500 and not a 5000, the initial conditions of the problem are impossible.

1:08:41See what I mean? In other words, it's impossible to say that if you increase the production that you lower the total cost, 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 so, and you can't even have it the same 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 so therefore the amount, the total cost always have to go up in other words, remember this is the minimum total cost the minimum can't be five thousand, and this can't be less than, because as I said, if you can't you can then produce the hundred and one pocket the one, and then you have, this will be forty five hundred and not five thousand

1:09:35this is an illogical illogical situation, violates the conditions of the problem so therefore total costs always have to go up, even if by a little bit The economies of large-scale production do not apply to total cost, they apply to average total cost, which is very different. It's total cost per unit that goes down for large-scale production, not total cost period. So this always is going up from the point of origin, which is zero, on up. So then the business firm has got to pick the maximum profit point. The maximum profit point will be the largest distance between total revenue and total cost. 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 The conditions for say, take this as the maximum distance between total revenue and total costs Those of you who have taken differential calculus will immediately begin to see the analogies here At this point, there's a maximum difference between these two.

1:10:44The slope of the, tangent of the slope, yeah, tangent of the slope will be equal. The total cost curve and the total revenue curve will be the same at maximum distance. This is the tangent, delta change in TR divided by delta Q, and this is change in TC divided by delta Q. This is also known as marginal revenue, the change in total revenue, whether increase or decrease. With one more unit of quantity, there's the marginal revenue and the change in total cost, There's always going up, remember, one more unit of cost, marginal cost, where these two things are the slope of the same, the marginal revenue and marginal cost are equal.

1:11:38This is the famous marginal revenue and marginal cost criterion. All it's really saying is, it's not saying anything else than the total revenue, the total profits are maximized. 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. MR is delta TR over delta Q, MC is delta TC over delta Q. The way you have, when the change is infinitely, this is where differential calculus comes in, when the change is infinitely small, infinitesimally small, then this becomes first derivative, DTR versus over DQ, etc. Unfortunately, in human action, you don't have infinitesimally small steps.

1:12:26Therefore, calculus is really illegitimate in this situation. However, this is my gripe with mathematical economics in general. But this is where this thing comes from. Taking infinitely small steps, you will get, then, this first derivative, delta dT or marginal revenue is equal to marginal cost. But you're not saying anything more, notice. You're not saying anything more of interest than simply you're trying to maximize profit. This is a criterion for maximizing profit. That's all there is to it. This is a whole shtick. Millions of words are wasted and economics works on this whole topic. another problem with this is once you realize there might be more than one peak this could also be a minimum this could also identify a minimum profit point or it could be another maximum, so which is better? you can only find out which is better which is minimum, which is maximum by inspecting the total you're back on the total again, minimum so the marginal stuff really misleads you more than anything else

1:13:24so it's an interesting way of looking at it in many ways helpful to show what's going on 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. You want to make sure you're taking in at least as much as you're paying out, hopefully, of course, more. But the main point is that the total is really the key. The key is you're trying to make total profits. The rest of the stuff, you can see how the mathematical economists get wrapped up in this. You get fascinated by the tangencies, by slopes, and all that sort of stuff, but it's really all subordinate to the main problem. Business man cares about profits and losses, he doesn't really care about the other stuff, and this is why when economists talk to business men, it's all breakdown of communication. What do you mean by marginal?

1:14:09They don't understand what marginal cost is, marginal, and for good reason. Most of it is a lot of periphery, frippery, I would say, useless frippery on the main topic. At any rate, so if you have more than, especially as I say, if you have more than one peak, If you think you can get into big trouble by only talking about marginal, because it could easily be a minimal profit. It's the only way to make sure by looking at the actual totals. So the whole point here is to say maximize total revenue minus total cost, and the equality of marginal revenue and marginal cost is an interesting property of a maximum profit situation. This gives us our marginal revenue and marginal cost. Marginal revenue is delta tc over delta q.

1:15:02When delta q is 1, of course, it becomes very easy to look, you know, just delta tr. And marginal cost is delta tc over delta q. The other thing, the average comes in, again it's fairly simple now, the average revenue is TR over Q. That's the average revenue per unit, average revenue per unit produced. That's the same thing as price. In other words, if you're selling five cases of widgets at $5,000, You're selling $1,000 per case. That's what price is. This is our demand curve, in other words. Same thing, remember P times Q is equal to TR. So average revenue is the same thing as price.

1:15:50That's where it all fits in. This is why you have these two curves. The total revenue curve here, and the average revenue curve, which is the demand curve. Price and quantity. Average cost is total cost divided by quantity. This is average total cost, I should say, because I don't talk about average fixed cost, average variable, it's all nonsense. 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. $10,000 per unit. In other words, you divide the total cost per unit. Its average total cost often falls spectacularly from large scale production. not the total, the average total, the total cost per unit okay, alright, this is enough for you to absorb this time we'll continue on with this stuff and I'll give you back your exams