[Script Info]
Title: 
[Events]
Format: Layer, Start, End, Style, Name, MarginL, MarginR, MarginV, Effect, Text
Dialogue: 0,0:00:00.00,0:00:03.00,Default,,0000,0000,0000,,♪ [music] ♪
Dialogue: 0,0:00:09.17,0:00:11.01,Default,,0000,0000,0000,,- [Alex] Now that we know \Nhow to find the profit
Dialogue: 0,0:00:11.01,0:00:14.01,Default,,0000,0000,0000,,maximization point, \Nwe're going to show
Dialogue: 0,0:00:14.01,0:00:18.81,Default,,0000,0000,0000,,the amount of profit on the diagram \Nusing the average cost curve.
Dialogue: 0,0:00:23.96,0:00:25.59,Default,,0000,0000,0000,,So as I said in the last lecture,
Dialogue: 0,0:00:25.59,0:00:28.09,Default,,0000,0000,0000,,average cost is the cost \Nper unit of output.
Dialogue: 0,0:00:28.09,0:00:32.78,Default,,0000,0000,0000,,That is, average cost is\Ntotal cost divided by Q.
Dialogue: 0,0:00:32.78,0:00:36.11,Default,,0000,0000,0000,,Now remember also \Nthat total cost can be broken down
Dialogue: 0,0:00:36.11,0:00:39.02,Default,,0000,0000,0000,,into fixed costs plus \Nvariable costs.
Dialogue: 0,0:00:39.02,0:00:42.55,Default,,0000,0000,0000,,So we can also write average cost\Nin a slightly longer format.
Dialogue: 0,0:00:42.55,0:00:46.46,Default,,0000,0000,0000,,Average cost is equal \Nto fixed cost divided by Q
Dialogue: 0,0:00:46.46,0:00:52.71,Default,,0000,0000,0000,,variable cost divided by Q --\Nthe units of output.
Dialogue: 0,0:00:52.89,0:00:57.66,Default,,0000,0000,0000,,we're able to see, get some intuition, for\Nthe shape of a typical average cost curve.
Dialogue: 0,0:00:57.84,0:01:05.28,Default,,0000,0000,0000,,Notice that the fixed costs don't change\Nwith Q. That's why they're fixed. So when Q
Dialogue: 0,0:01:05.46,0:01:11.14,Default,,0000,0000,0000,,is small, this number, suppose fixed cost\Nis a hundred and Q is small, then this
Dialogue: 0,0:01:11.32,0:01:18.08,Default,,0000,0000,0000,,number is going to be big like 100 divided\Nby 1. As Q gets larger, however, this number -
Dialogue: 0,0:01:18.26,0:01:23.22,Default,,0000,0000,0000,,fixed cost divided Q - is going to get\Nsmaller, so when Q is 10 this number 100
Dialogue: 0,0:01:23.40,0:01:29.17,Default,,0000,0000,0000,,divided by 10 becomes 10. So it goes from\N100 and it goes down, down, down, down,
Dialogue: 0,0:01:29.35,0:01:32.34,Default,,0000,0000,0000,,get's lower and lower and lower all the\Ntime as you divide by a bigger
Dialogue: 0,0:01:32.52,0:01:39.27,Default,,0000,0000,0000,,quantity. On the other hand, the variable\Ncosts increase with quantity. Moreover,
Dialogue: 0,0:01:39.27,0:01:44.26,Default,,0000,0000,0000,,what we saw with the marginal cost curve\Nis that at some point your variable costs
Dialogue: 0,0:01:44.26,0:01:48.92,Default,,0000,0000,0000,,are going to increase faster than\Nquantity. So what's going to happen is
Dialogue: 0,0:01:48.92,0:01:52.93,Default,,0000,0000,0000,,that this number at some point - variable\Ncost divided by quantity - is going to get
Dialogue: 0,0:01:52.93,0:01:58.29,Default,,0000,0000,0000,,bigger and bigger and bigger. So you have\Ntwo things one force is driving average
Dialogue: 0,0:01:58.29,0:02:03.04,Default,,0000,0000,0000,,cost down. That's going to be\Nparticularly strong at the beginning.
Dialogue: 0,0:02:03.22,0:02:09.70,Default,,0000,0000,0000,,Eventually however, the second force here\Nis going to drive average cost, uh, up. So
Dialogue: 0,0:02:09.88,0:02:13.11,Default,,0000,0000,0000,,that's going to be our typical shape of an\Naverage cost curve - falling reaches a
Dialogue: 0,0:02:13.29,0:02:17.64,Default,,0000,0000,0000,,minimum and then rising. So let's draw it\Nlike that. Okay here's our typical
Dialogue: 0,0:02:17.82,0:02:22.83,Default,,0000,0000,0000,,marginal cost curve and here is our\Nmarginal revenue curve equal to price. We
Dialogue: 0,0:02:23.01,0:02:27.02,Default,,0000,0000,0000,,know that the profit maximizing point is\Nwhere marginal revenue is equal to
Dialogue: 0,0:02:27.20,0:02:31.98,Default,,0000,0000,0000,,marginal cost. Here is our average cost\Ncurve and notice it has the shape, which I
Dialogue: 0,0:02:32.16,0:02:36.85,Default,,0000,0000,0000,,described, it starts off high, it falls,\Nreaches a minimum, and then goes right back
Dialogue: 0,0:02:37.03,0:02:43.52,Default,,0000,0000,0000,,up again. Couple of other points to notice\Nis that the minimum point, the marginal
Dialogue: 0,0:02:43.70,0:02:49.16,Default,,0000,0000,0000,,cost curve goes through the minimum point\Nof the average cost curve. Now that's just
Dialogue: 0,0:02:49.34,0:02:53.73,Default,,0000,0000,0000,,a mathematical fact, but let me give you\Nsome intuition. Instead of cost I want to
Dialogue: 0,0:02:53.91,0:02:59.93,Default,,0000,0000,0000,,talk about average grade and marginal\Ngrade. So suppose that your average grade
Dialogue: 0,0:03:00.11,0:03:05.64,Default,,0000,0000,0000,,is 80%. You're doing really pretty good.\NBut then on your next test you only get
Dialogue: 0,0:03:05.82,0:03:11.60,Default,,0000,0000,0000,,60% - lower. What is that going to do to\Nyour average? Well, it's going to drive
Dialogue: 0,0:03:11.60,0:03:18.64,Default,,0000,0000,0000,,your average down. Indeed whenever your\Nmarginal is below your average, the average
Dialogue: 0,0:03:18.82,0:03:24.73,Default,,0000,0000,0000,,must be falling. On the other hand,\Nsuppose that you're getting, uh, 80% and on
Dialogue: 0,0:03:24.91,0:03:30.60,Default,,0000,0000,0000,,your next test you get 90%. Great, but what\Ndoes that do to your average? It drives your
Dialogue: 0,0:03:30.78,0:03:36.71,Default,,0000,0000,0000,,average up. Indeed whenever your marginal\Nis above the average, the average must be
Dialogue: 0,0:03:36.89,0:03:42.34,Default,,0000,0000,0000,,rising. Now suppose what happens when\Nyou're getting let's say 80%, and on your
Dialogue: 0,0:03:42.52,0:03:49.63,Default,,0000,0000,0000,,next test you also get 80%. Well then your\Nmarginal is equal to your average grade
Dialogue: 0,0:03:49.81,0:03:55.70,Default,,0000,0000,0000,,and your average grade is flat - it doesn't\Nchange, it's flat. But what is true for
Dialogue: 0,0:03:55.88,0:04:01.24,Default,,0000,0000,0000,,average and marginal grades is also true\Nfor average cost and marginal cost.
Dialogue: 0,0:04:01.42,0:04:09.18,Default,,0000,0000,0000,,Whenever the marginal cost is below the\Naverage, the average is falling. Whenever
Dialogue: 0,0:04:09.36,0:04:15.09,Default,,0000,0000,0000,,the marginal cost is above the average, the\Naverage is rising. And where marginal is
Dialogue: 0,0:04:15.27,0:04:21.21,Default,,0000,0000,0000,,just equal to average, the average is flat.\NIn other words we are at the minimum point
Dialogue: 0,0:04:21.39,0:04:26.60,Default,,0000,0000,0000,,of the average cost curve. Okay, now I\Nsaid we could use the average cost curve
Dialogue: 0,0:04:26.78,0:04:30.80,Default,,0000,0000,0000,,to figure out profit - show profit on the\Ndiagram. We can do that with just a little
Dialogue: 0,0:04:30.98,0:04:36.40,Default,,0000,0000,0000,,bit of rearranging. Remember that profit\Nis equal to total revenue minus total cost
Dialogue: 0,0:04:36.58,0:04:41.72,Default,,0000,0000,0000,,and total revenue is price times quantity -\NP times Q. We also know that average cost
Dialogue: 0,0:04:41.90,0:04:46.83,Default,,0000,0000,0000,,is equal to total cost divided by\Nquantity. Let's just rearrange that to
Dialogue: 0,0:04:47.01,0:04:51.89,Default,,0000,0000,0000,,tell us that total cost is equal to\Naverage cost times quantity. So just take
Dialogue: 0,0:04:52.07,0:04:58.42,Default,,0000,0000,0000,,this one and multiply both sides by Q.\NSo, let's now make these substitutions into
Dialogue: 0,0:04:58.60,0:05:04.32,Default,,0000,0000,0000,,our profit equation. If we do that, then\Nprofit is equal to total revenue - price
Dialogue: 0,0:05:04.50,0:05:10.55,Default,,0000,0000,0000,,times quantity - minus total cost - average\Ncost times quantity. Now let's take Q out
Dialogue: 0,0:05:10.73,0:05:16.52,Default,,0000,0000,0000,,of both parts of this equation and we find\Nthat profit can also be written as price
Dialogue: 0,0:05:16.70,0:05:22.81,Default,,0000,0000,0000,,minus average cost, all of that times\Nquantity. That's nice because we can find
Dialogue: 0,0:05:22.99,0:05:30.57,Default,,0000,0000,0000,,all of these elements on our diagram.\NHere's the price. Here's the average cost
Dialogue: 0,0:05:30.75,0:05:36.42,Default,,0000,0000,0000,,at the profit maximizing quantity. Let's\Njust show that. There's the price. There's
Dialogue: 0,0:05:36.60,0:05:42.19,Default,,0000,0000,0000,,the average cost at the profit maximizing\Nquantity. So profit at the profit
Dialogue: 0,0:05:42.37,0:05:51.11,Default,,0000,0000,0000,,maximizing quantity is this green area\Nright here. Price minus average cost times
Dialogue: 0,0:05:51.29,0:05:56.26,Default,,0000,0000,0000,,quantity. So now we have a nice way of\Nshowing in a diagram exactly how much
Dialogue: 0,0:05:56.44,0:06:02.09,Default,,0000,0000,0000,,profit is. Let's use this tool some more.\NHere's another example of the average cost
Dialogue: 0,0:06:02.27,0:06:06.71,Default,,0000,0000,0000,,curve in action. Remember I said that\Nprofit maximization doesn't necessarily
Dialogue: 0,0:06:06.89,0:06:11.45,Default,,0000,0000,0000,,mean the firm is making a positive profit.\NSometimes the best you can do is to
Dialogue: 0,0:06:11.63,0:06:16.63,Default,,0000,0000,0000,,minimize your losses. You may have to take\Na loss. For example, suppose that the
Dialogue: 0,0:06:16.81,0:06:22.72,Default,,0000,0000,0000,,price is below $17. That is, here's the market\Nprice, which is equal to the firm's marginal
Dialogue: 0,0:06:22.90,0:06:27.75,Default,,0000,0000,0000,,revenue curve. How does the firm profit\Nmaximize? It chooses the quantity where
Dialogue: 0,0:06:27.93,0:06:33.39,Default,,0000,0000,0000,,marginal revenue is equal to marginal cost.\NIn that case, this quantity is one. Now
Dialogue: 0,0:06:33.57,0:06:40.00,Default,,0000,0000,0000,,what's the profit for the firm? Well, as\Nusual we measure profit as price minus
Dialogue: 0,0:06:40.18,0:06:47.91,Default,,0000,0000,0000,,average cost times quantity. But notice\Nthat price is below the average cost at
Dialogue: 0,0:06:48.09,0:06:54.98,Default,,0000,0000,0000,,the profit maximizing quantity of one.\NSince price is below average cost, this is
Dialogue: 0,0:06:55.16,0:07:03.92,Default,,0000,0000,0000,,a loss. It's a negative quantity. It is a\Nloss. In fact, notice that the breakeven
Dialogue: 0,0:07:04.10,0:07:10.68,Default,,0000,0000,0000,,price is $17, which is the minimum of the\Naverage cost curve. In order to make a
Dialogue: 0,0:07:10.86,0:07:17.92,Default,,0000,0000,0000,,profit, the firm at least has to meet the\Nminimum of it's average cost curve. So at
Dialogue: 0,0:07:18.10,0:07:23.26,Default,,0000,0000,0000,,any price below $17 we'll be profit\Nmaximizing at a point where price is equal
Dialogue: 0,0:07:23.44,0:07:29.05,Default,,0000,0000,0000,,to marginal cost, and notice that all of\Nthese prices are below average cost. So
Dialogue: 0,0:07:29.23,0:07:35.37,Default,,0000,0000,0000,,all of this area down here, even the\Nprofit maximizing quantity, will mean a
Dialogue: 0,0:07:35.55,0:07:41.94,Default,,0000,0000,0000,,loss. On the other hand, once we get above\N$17, above the minimum of the average cost
Dialogue: 0,0:07:42.12,0:07:47.60,Default,,0000,0000,0000,,curve, then we can price equal to marginal\Ncost. We can chose the quantities such the
Dialogue: 0,0:07:47.78,0:07:52.64,Default,,0000,0000,0000,,price is equal to marginal cost. That price\Nwill be above average cost so we'll be
Dialogue: 0,0:07:52.82,0:08:00.36,Default,,0000,0000,0000,,taking a profit. Therefore, $17, the minimum\Nof the average cost curve, is the
Dialogue: 0,0:08:00.54,0:08:04.19,Default,,0000,0000,0000,,breakeven point.\NIf the price is less than the minimum of
Dialogue: 0,0:08:04.37,0:08:08.97,Default,,0000,0000,0000,,the average cost curve, we're going to be\Ntaking a loss. If the price is bigger than
Dialogue: 0,0:08:09.15,0:08:13.49,Default,,0000,0000,0000,,the minimum of the average cost curve, then\Nwe can make a profit. So when should a
Dialogue: 0,0:08:13.67,0:08:19.37,Default,,0000,0000,0000,,firm enter or exit an industry? In the\Nlong run, the firms will enter when price
Dialogue: 0,0:08:19.55,0:08:23.86,Default,,0000,0000,0000,,is above average cost. If price is\Nsomewhere above the average cost curve
Dialogue: 0,0:08:24.04,0:08:27.85,Default,,0000,0000,0000,,then the firm can make a profit by\Nentering and that's what firms want to do.
Dialogue: 0,0:08:28.03,0:08:31.34,Default,,0000,0000,0000,,They want to find profit, so they will\Nwant to enter wherever a profit is
Dialogue: 0,0:08:31.52,0:08:36.59,Default,,0000,0000,0000,,possible. Firms will exit the industry\Nwhen the price is below the average cost
Dialogue: 0,0:08:36.77,0:08:41.46,Default,,0000,0000,0000,,curve. Then they're going to be taking a\Nloss and they're going to want to exit. So
Dialogue: 0,0:08:41.64,0:08:45.72,Default,,0000,0000,0000,,finally, when the price is equal to the\Nminimum of the average cost - it's just
Dialogue: 0,0:08:45.90,0:08:50.69,Default,,0000,0000,0000,,equal to the bottom of the average cost\Ncurve, profits are zero and there's no
Dialogue: 0,0:08:50.87,0:08:55.69,Default,,0000,0000,0000,,incentive to either exit or enter the\Nindustry. Now you might ask, why would
Dialogue: 0,0:08:55.87,0:09:02.38,Default,,0000,0000,0000,,firms remain in an industry if profits are\Nzero? Zero profits, this is just a matter
Dialogue: 0,0:09:02.56,0:09:07.37,Default,,0000,0000,0000,,of terminology, means that at the market\Nprice the firm is covering all of its
Dialogue: 0,0:09:07.55,0:09:13.41,Default,,0000,0000,0000,,costs including enough to pay labor and\Ncapital, their ordinary opportunity cost.
Dialogue: 0,0:09:13.59,0:09:18.22,Default,,0000,0000,0000,,So zero profits means everyone\Nis being paid, enough to make
Dialogue: 0,0:09:18.40,0:09:24.51,Default,,0000,0000,0000,,them satisfied. Zero profits, in other\Nwords, is what normal people mean by normal
Dialogue: 0,0:09:24.69,0:09:30.38,Default,,0000,0000,0000,,profits. So when an economist says zero\Nprofits just substitute normal profits.
Dialogue: 0,0:09:30.56,0:09:35.04,Default,,0000,0000,0000,,One more point about entry and exit. It\Ndoesn't always make sense to exit an
Dialogue: 0,0:09:35.22,0:09:40.89,Default,,0000,0000,0000,,industry immediately when price falls\Nbelow average cost. Or to enter immediately
Dialogue: 0,0:09:41.07,0:09:48.32,Default,,0000,0000,0000,,when price is above average cost. Why not?\NWell, there are also entry and exit costs.
Dialogue: 0,0:09:48.50,0:09:53.40,Default,,0000,0000,0000,,For example, suppose that that the price\Nof oil is currently above the average cost
Dialogue: 0,0:09:53.58,0:09:59.26,Default,,0000,0000,0000,,of pumping oil, if you've already got a\Nwell. Should you enter the industry? Well,
Dialogue: 0,0:09:59.44,0:10:05.25,Default,,0000,0000,0000,,maybe not necessarily. Because entry\Nrequires you to drill an oil well, and
Dialogue: 0,0:10:05.43,0:10:08.98,Default,,0000,0000,0000,,drilling an oil well is a sunk cost -\Nliterally in this case.
Dialogue: 0,0:10:09.16,0:10:15.78,Default,,0000,0000,0000,,A sunk cost is a cost that once incurred\Ncan never be recovered. So if you enter
Dialogue: 0,0:10:15.96,0:10:20.69,Default,,0000,0000,0000,,the industry and drill the oil well, you\Ndon't get that money back when you later
Dialogue: 0,0:10:20.87,0:10:28.16,Default,,0000,0000,0000,,exit the industry. What this means is you\Ndon't want to enter unless you expect the
Dialogue: 0,0:10:28.34,0:10:35.86,Default,,0000,0000,0000,,price of oil to stay above the minimum of\Nthe average cost curve long enough so
Dialogue: 0,0:10:36.04,0:10:41.68,Default,,0000,0000,0000,,that you can also recover your entry\Ncosts. So just because the price goes
Dialogue: 0,0:10:41.86,0:10:45.77,Default,,0000,0000,0000,,above the average cost a little bit, you\Ndon't immediately want to jump into that
Dialogue: 0,0:10:45.95,0:10:52.12,Default,,0000,0000,0000,,industry. You have to expect that that\Nprice is going to stay above average cost
Dialogue: 0,0:10:52.30,0:10:58.90,Default,,0000,0000,0000,,long enough for you to recover your entry\Ncosts. For the same reasons, if there are
Dialogue: 0,0:10:59.08,0:11:03.48,Default,,0000,0000,0000,,exit costs, for example, if you have to\Nshutter up the well or fill the well with
Dialogue: 0,0:11:03.66,0:11:07.85,Default,,0000,0000,0000,,cement when you exit the industry as you\Ndo in the United States, then when price
Dialogue: 0,0:11:08.03,0:11:13.46,Default,,0000,0000,0000,,falls below average cost, it may be best to\Nweather the storm at least for sometime
Dialogue: 0,0:11:13.64,0:11:21.06,Default,,0000,0000,0000,,before you exit. Only if you expect the\Nprice of oil to stay below your minimum of
Dialogue: 0,0:11:21.24,0:11:26.55,Default,,0000,0000,0000,,average cost for an extended period of\Ntime will you want to exit the industry.
Dialogue: 0,0:11:26.73,0:11:31.67,Default,,0000,0000,0000,,After all, if the price of oil falls below\Nthe average cost just for a little bit, and
Dialogue: 0,0:11:31.85,0:11:37.32,Default,,0000,0000,0000,,then it goes back up, the lifetime\Nprofits can still be possible. So, entry
Dialogue: 0,0:11:37.50,0:11:40.81,Default,,0000,0000,0000,,and exit could be quite complicated\Nbecause you've got to be thinking about
Dialogue: 0,0:11:40.99,0:11:46.94,Default,,0000,0000,0000,,the lifetime profits, not just your\Nimmediate profits. However, the bottom
Dialogue: 0,0:11:46.94,0:11:53.11,Default,,0000,0000,0000,,line is pretty simple. Firms seek profits\Nand they want to avoid losses. As a
Dialogue: 0,0:11:53.11,0:11:57.64,Default,,0000,0000,0000,,result, firms will enter industries when\Nthe price is above the average cost and
Dialogue: 0,0:11:57.64,0:12:02.13,Default,,0000,0000,0000,,they can make a profit, and they will exit\Nwhen the price is below the average cost.
Dialogue: 0,0:12:02.13,0:12:03.89,Default,,0000,0000,0000,,Thanks.
Dialogue: 0,0:12:04.42,0:12:09.41,Default,,0000,0000,0000,,- [Announcer] If you want to test yourself,\Nclick, "Practice Questions," or if you're
Dialogue: 0,0:12:09.59,0:12:12.18,Default,,0000,0000,0000,,ready to move on,\Njust click, "Next Video."
Dialogue: 0,0:12:12.18,0:12:15.17,Default,,0000,0000,0000,,♪ [music] ♪