Revenue, Profits, and Price: Crash Course Economics #24

After last week’s more theoretical discussion on the what-ifs of the US education system, Crash Course comes back to hard textbook economics in week 24.  What’s even better is that this week’s topic falls within microeconomics, which is the most agreeable and least controversial area of economics.

Crash Course doesn’t make any objectionable comments in this video, but there are some points I’d like to flesh out, especially because I know it’ll be helpful when reviewing future episodes.  Let’s get to it:

Opportunity Costs

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Let’s say a lawyer stops practicing law and decides to open up a pizza parlor. Let’s say his total revenue from selling pizza is $50,000 and he has to pay $20,000 to cover stuff like the ingredients, the oven, rent, and wages. Now, an accountant would calculate his profit, the revenue minus the costs, as $30,000. Not bad. But an economist recognizes that there‘s a cost missing: the opportunity cost. Our pizza entrepreneur loses the income he would have earned by being a lawyer, let’s say $100,000. If you factor that in, he is actually losing $70,000.

The concept of opportunity costs is so fundamental to economics, it cannot be overstated.  Crash Course’s example is spot on here with the example of a private business owner.

However, this principle of opportunity cost might be even more important in public policy work.  When a government spends tax revenue on a particular project, it’s easy to look at the project and say “Wow, how great is this!  We didn’t have this thing before, and now we do!  Thanks government!”

The problem occurs when you think about all the other places the money could have gone.  For example, instead of building an expensive statue in town square, the city government could have built shelters for the homeless, fix the potholes in the street, or subsidize a local medical clinic.  Or even better (to many economists), the money could be left in the hands of taxpayers, and then they can decide where to spend their money (spoiler: it probably wouldn’t be on a statue).

This problem of opportunity costs for public projects only gets bigger if you look at larger governments.  For example, the US federal government spent $3 million to research obesity rates for lesbians.  Do you think that, maybe, the money could be better spent on just about anything else?

No economist does a better job at explaining opportunity cost than Frederic Bastiat in his Parable of the Broken Window.  If you aren’t familiar with it, do yourself a favor and check it out.  It’s still changing the way many people think about spending and opportunity cost, and it’s 150 years old.

Businesses and Marginal Cost

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Businesses use this same logic. They calculate their potential revenue and their costs of production, including implicit costs, to make informed decisions […] eventually, they’ll get to a point where hiring another worker only adds one more pizza to their hourly total. Now, the marginal cost of that last pizza is huge. And, it’s likely to be higher than the additional revenue the company is gonna get from selling that pizza.

Crash Course then moves on to talk about a different subject without reaching the obvious conclusion: the business would not hire that additional worker.

This principle of marginal cost will be very important when talking about the minimum wage, which will have its own episode.  Crash Course has already stated in a previous episode that some universal economic principles do not apply when talking about the minimum wage, so we’ll see how they reconcile their lessons on marginal cost and price floors with the minimum wage when we get to it.

Economic Profit, Normal Profit, and Competition

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So there’s actually two types of profit. Accounting profit, which is revenue minus just explicit costs, those traditional out-of-pocket costs you think of when you run a business. And there’s Economic profit which is revenue minus explicit and implicit costs — which is those indire