Greetings, today we want to talk a bit more about what economists like to refer to as the theory of the firm. And in order to think about this, we're going to talk about behavioral rules and our behavioral rule is that firms maximize profits. It's important that some people who are interested in this course that are taking this course are going to say well Larry, I work for a non-profit. What do we do? Well, it turns out nonprofits and profits do the same thing. It's just that a profit-maximizing firm makes money and keeps it. The money belongs to the owners. The owners can, it may be that the owners are as you know, could be a diverse body of shareholders out there. We talked about shareholders back in a previous video or it could be that it's just a sole proprietor, individual, Larry's tree trimming shop who works and keeps the money. Not-for-profits also have the same efficiency issues. They have to deal with the same technology. It's not that there's a magic technology for not-for-profits. They have to deal with the same constraints as for-profit companies. It's just that what they do and their goal is to not distribute the money out to owners, their goal is to make money for a common cause. This not-for-profit is to is to make residuals that we can use towards helping people who need support for healthcare issues or working on environmental issues or working on childhood safety issues, all these sorts of things. The analysis is going to be the same but I'm going to refer to maximizing profits all the time. And if you do work for a not-for-profit, you say well, I guess that doesn't make what? Yeah it does. You still want to maximize the amount of money you make for the cause, for whatever the good cause is that you're being, that you're working toward in your nonprofit. And so to maximize profits, we know that the firm we're going to use for us this term, the Greek symbol pi is going to be profits for us for the rest of this course. And profits are equal to total revenue minus total cost. Profits are how much money do you bring in net of how much it cost for you to get there? How much you have to pay to make that product and then how much, what do we get for it? And then the difference, that residual is your profits and we're going to write it in a little bit simpler form. We're going to say profit is equal to total revenue minus total cost. So from now on when we see this term, we're just going to call this TR and when we see this term, we're going to call this TC. So, profits are equal to total revenue minus total costs. And it's important that we start here by laying out a little bit of the rules. This profit, for us this profit is what we call economic profit and it's economic profit because this cost function includes opportunity cost. The distinction is really important, when you see pi in this course, it means economic profit. There are other types of profits out there like accounting profit and we'll just talk a bit about that for you right now. We're going to add a page here and say that accounting profit, accounting profit we'll call accy, is equal to total revenue minus total explicit cost. I'm going to write out the econ one in a minute and then I'm going to come back and explain to you why am I making you go through all these things? Why are these things important? So I'm going to write instead alternatively straight pi, which is econ profit because this is an econ course, is equal to total revenue minus total explicit cost minus opportunity cost. So what's the big difference here? Well, accounting profit is the revenue you make minus what your explicit costs are. Well to an economists, that's not enough and let me tell you a story. So imagine, let's do this little example. It's a thought example. Imagine you were you were gainfully employed and had a job that you enjoyed and you were making about let's say $100,000 a year in this job. And all of a sudden you decide, you know what? I've got this idea that I want to open up a hot dog stand. I want to be a hot dog, a street vendor selling hot dogs on the on the side of on a sidewalk in a major city. So your order yourself a big shiny stainless steel hot dog cart and you go out on the corner of a busy street and you start selling hot dogs. At the end of the year, your accountant you hire an account. You gotta hire a very good accountant. We got good accounts here at the College of Business. Our accountancy program is ranked number one and number two depending on which survey you look at, so you get a really good accountant and the accountant goes with a really sharp pencil and comes back and says, you know what? It's amazing. I have taken all of your revenues. I subtracted off all of your costs including the parking tickets you got from the police because you put your hot dog cart in the wrong spot, all of that sort of stuff. Your total profits are still $78,000, $78,000. What a deal! I mean, you're a really good vendor. And in fact, you would have to report that on your taxes. Schedule C for your tax form says profit or loss from a business. The accountant would have provided you with a whole list of all your expenses and a whole list of all your revenues and you would write it on a Schedule C and there would be a net of $78,000. And that's what you'd have to pay because that would be your accounting profit. But to an economist, the economist says well you know what, that's true. I see those total revenue and I see the total explicit cost but there's also the opportunity cost. You made $78,000, but you also have to subtract off the fact that you could have been making $100,000 if you stayed your other job. So economists worry a lot about these opportunity costs. Now, you might say come on Larry. What about the fact that you're your own boss? He's certainly gets a lot of happiness about the fact that he doesn't have to go punch a time clock and live in a cubicle. Now, he gets out of the street selling dogs. We can quibble about that and in fact, economists can do some statistical estimation to see how much that's really worth. But the fact of the matter is that economists want to include this opportunity cost because it's fundamentally important to think about where resources flow. Economists like to say the following. Imagine you're the boss of a big company and the accountant walks in, puts the books down for the third quarter and says boss, I can't believe it. For the third quarter we made seven million dollars. You are a genius. We made seven million dollars. It's a tough climate out there and we made seven million dollars, congratulations. The accountant walks out. The sign of a really good manager is that manager, first question that manager asked is what could we have made if we were elsewhere? What if we just liquidated this company and started producing Twinkies? What if we changed this company and decided to start running cruise ships off of the coast of Texas? There's all sorts of things we might be doing that could be better. Good managers are constantly calculating okay, I can see what I'm going to have to report to the government. That's my accounting profit. But the question is, could I have made more elsewhere and if I could, if I could have made more elsewhere then this number is going to be greater than these two and you're going to be losing money. That's what causes people to make these moves. Think all the way back to our very first video when we had that little yellow sheet of paper from Infoworld and we talked about the fact that those memory prices were insane, $2,500 for a four megabyte chip. But the thing is, that's what causes people to make decisions. I say you know, look I'm making a pretty good living here working at this bookstore in the Midwest, but I'm telling you, I could make a killing if I went out there. People make these decisions on their own. No one puts a gun to her head and says move out to Silicon Valley. People do it because they make a calculation that even though they're making a nice living here at this job, they could do better over there, and that's what causes resource flows. Thanks.
