Gini Coefficient and Lorenz Curve

WEBVTT
Kind: captions
Language: en

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- [Instructor] In this video,

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we're going to discuss income inequality,

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which is something that is often debated,

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thinking about comparing countries,

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thinking about whether
it's an issue or not

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and how to address it.

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And to appreciate what
income inequality is,

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let's imagine two different countries.

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Let's imagine first, country A,

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and there's two people in country A.

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So, you have person one here,

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who makes $1000 a year,
that's their income,

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and then there's person two in country A

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that makes $99,000 a year.

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So, what is going to be the average income

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in country A, if these
are the only two people?

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Or you could think of it as
the per capita national income.

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Well the average income here,

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average income, to figure that out,

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you would just have to average
the 1000 and the 99,000.

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So you have a total income
of one plus 99, 100,000

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divided by two folks,

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well you're gonna have an average income

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of $50,000 per year.

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Now, let me construct another country

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that has the same average income,

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but the distribution is very different.

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So in country B, let's say the
first citizen of country B,

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they make $50,000 a year,

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and let's say there's a
second person in country B,

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and they also make $50,000 per year,

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per year.

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Well, what's the average income now?

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Well, this is even easier
to compute, 50 plus 50

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divided by two, your average
income is $50,000 per year.

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So, what you see here is two countries

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that if you just looked
at the average income,

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they seem similarly wealthy,

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but that doesn't give you,

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they seem to have similar average incomes.

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So you would say, oh maybe
they're similarly prosperous.

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But when you go a step deeper,

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you see that they are very different.

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Country A is a lot more
unequal than country B,

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when it comes to income.

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So, question is, is above
and beyond looking at things

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like average income or
average GDP or per capita GDP,

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how do you measure inequality?

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And this is something that
this Italian statistician,

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Corrado Gini, tried to address,

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and he comes up with something
called a Gini coefficient

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to measure income inequality for a nation.

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And the way he approached it
is actually pretty intuitive.

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What he did is he sets up two axes.

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So, this axis right
over here is going to be

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the cumulative percentage
of the population.

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So, you start at 0% and then
you get all the way to 100%

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of the population.

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So this is the cumulative
percent of the population

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in a country, and then on
this axis, on this axis,

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you have the cumulative percentage

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of the income in a country.

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So, this would be zero down here

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and then this would be 100 up there.

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And so, this is cumulative percent

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of income in a country,

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and then he said,

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well what would a perfectly
equal society look like?

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Well in a perfectly equal society,

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as you add a percentage

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on your cumulative
percentage of population,

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you should add that exact same percentage

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to your cumulative percentage of income.

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So as you go up, you really
should just have a slope of one

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going up like this.

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So, one way to think about it is,

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when you're at 0% of the population,

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you should have 0% of the income.

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If you have a total of
10% of the population,

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they should have 10%
of the national income.

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If you were to go to
50% of the population,

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which looks like it's around there,

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if it was perfectly
distributed, the income,

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well then that should be
50% of the national income.

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But no nation is actually there,

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and so then we have to then
compare that to the reality.

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So, let's say you look at a country,

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and what you do is,

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when you're looking at
the cumulative percentage

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of the population, you start at the left

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with the lowest income,
and as you add percentages

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of the population, you get to higher

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and higher income folks.

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So, let's say we're looking at a country

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that for the poorest folks,

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as you add percentages to
the cumulative population,

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you're not adding the same
percent to the cumulative income.

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And so, you might have a
curve that looks like this,

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and then as you add percentages
in the wealthier population,

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for every 1% you add, you're adding

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more than 1% of national income.

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And so, this curve right over here,

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which you could view as
describing the reality

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for a certain nation,

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this is known as a Lorenz curve,

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Lorenz curve, and what Gini said is,

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well the difference
between the Lorenz curve

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and this line right over here,

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that that would be a measure
of income inequality.

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And so, he would look at this area

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right over here, and say,
what percentage is this area

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between this line and the Lorenz curve,

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what percentage is this of
this total area under the line?

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And this percentage is
called the Gini coefficient,

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and it's typically quoted as being a value

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from zero to one,

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or sometimes you might
see the scale as being

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from zero to 100.

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So, what would a Gini
coefficient of zero represent?

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Well, if you have a Gini
coefficient of zero,

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that means that this area right over here

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between the Lorenz curve
and this line is zero.

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So that means that we are dealing

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with a perfectly equal
income distribution.

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So at the zero end, this
is perfect equality,

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perfect income equality,

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and then what does one or 100 mean?

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That means that the area between the line

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and the Lorenz curve is 100%
of the area under this line.

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So that would look like
something like this,

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a country whose Lorenz curve
looks like something like this,

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where all of these people,

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I keep adding more and
more and more population,

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but I'm not adding more and more income,

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and then all of a sudden, you
get to the very last person,

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and then that person
has all of the income.

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So, that person has all of the income.

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Well in that case,

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the Gini coefficient would be
the percentage of this area,

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which would be 100%,

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which we could view as a one or 100.

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And so, an interesting thing to do is,

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is look at Gini coefficients
for various countries

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and compare them.

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And that's exactly what
we have here on this map,

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and you can see that the
countries that are shaded red,

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these are countries that
have high Gini coefficients.

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So, this is where you have
more income inequality,

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and the ones that are
shaded green are the ones

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where you have relatively low Gini indices

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or Gini coefficients, and
so that would be indicative

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of reasonably low income inequality.

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Now, it's important to point out,

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you might think that red is always bad

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and green is always good,

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but this just tells you inequality,

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it does not tell you on average
how prosperous folks are,

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what average income is in that country,

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and so, this is an indication

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that in places like Latin
America and Sub-Saharan Africa,

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you definitely have very high inequality,

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and places like Canada and Europe,

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you seem to have very low inequality,

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but it doesn't tell you that people

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for sure are better off in Canada

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than say the United States.

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For example, you could have
a higher average income

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in the United States
than you have in Canada,

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and one can have a very spirited debate,

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which one you would rather be.

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Would you rather be in a country
that has higher inequality

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and higher average income

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or one that has lower
income and lower inequality?


Connecting income to capital growth and potential inequality

WEBVTT
Kind: captions
Language: en

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- [Sal] We've already talked quite a bit

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about the idea that if, look,

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if you have a market,
capitalist economy, that some,

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that this will lead,
hopefully, to economic growth,

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economic growth, but by definition,

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a market economy will have
some folks who win more

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and some folks who don't do as well,

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and it's going to, you're
also going to have inequality.

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Inequality; so inequality is
essentially a fact of life

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of a market economy,
and it's not necessarily

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something that you just wanna turn off,

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because that might also
hurt economic growth,

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and that actually might
make everyone better off

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because the economic growth
on a per capita basis

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could also be benefiting people

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who aren't in the top percentile
or decile or quartile.

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Not always, but it could be.

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But with that thought
in the back of our mind,

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let's actually think a little bit more

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about inequality and how it's measured,

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and how it can be tied
to things like capital

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and growth of income to
capital and returns on capital.

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So this right over here, this
is from Thomas Piketty's book,

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and what's neat is he's
made all of the charts

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of his book available
online, right over there,

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and this shows income
inequality in the United States

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between 1910 and 2010,
and what you see here,

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he measures it by the share of top decile

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in national income.

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So top decile's the top 10%,
so this point right over here

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tells us that in 1910,
the top 10% of earners

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made a little over 40%
of the national income.

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As we go into the late
20s, that approaches 50%

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of the top, the top 10% of earners

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were making close to half
of the national income.

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And then as we go through
the Great Depression,

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and especially after World War II,

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this drops down into the low 30%s,

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and then from the 1980s to the present,

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this has crept back up
to the high 40% range.

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So the top decile, the top 10% of earners,

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are making close to half
of the national income.

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Now let's just visualize how
this happens, just numerically.

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So let's imagine this is
your economy in year one.

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So this is your economy in year one.

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Actually, let me copy and paste that.

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I think that'll be useful.

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So copy, all right.

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And let's say that this is the fraction,

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I'll do it in orange, that
is going to the top decile.

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So let's say it's roughly
a third in year one.

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So this is the fraction that's
going to the top decile.

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This is 1/3 right over here.

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So the way that you have rising,

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so on this chart, this
would be kind of a 33.3,

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so it would be someplace around here,

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so we could pretend like we're some date

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in the 60s or 70s right over here,

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and now the way that you
have this chart moving up,

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where you have the top decile

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having a larger and larger
share of national income,

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is if this orange section grows faster

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than this green section.

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So for example, this grew by 10%

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while this grew by 5%,

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by 5%, over time this orange section

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is going to take a larger and larger chunk

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of the green section.

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Now as we saw in previous videos,

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even if this does happen,
and this is by definition

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rising inequality, there
could be a scenario

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where the other 90% are
still having a bigger pie,

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and on a per capita
basis still might be able

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to be better off.

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But the focus of this video is not that.

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The focus of the video is tying this idea

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to the idea of increasing
returns on capital

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driving this phenomenon,
driving inequality,

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income inequality.

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So as we've seen before, income and wealth

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are not the same thing, but
wealth could be a proxy.

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The more wealth that
you have, you will have

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more income from that wealth.

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You will have return on that capital.

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So another way to divide the economy

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is instead of thinking
of the top 10% of earners

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and the other 90% of
earners, you could think of

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how much of this income goes
to the owners of capital,

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and how much of it goes to the
people who provide the labor?

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So it's more of a labor-capital split

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versus the bottom 90%-top 10% split.

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So here we could think of
this section right over here,

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and I'll just make it a different,

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so let's say this is right over here,

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this is how much is going
to owners of capital,

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to capital, to owners of capital,

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the people who own the
buildings, the real estate,

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the resources, and how
much of national income

00:04:55.450 --> 00:04:57.540
is going to labor.

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So this right over here,
this right over here

00:05:01.070 --> 00:05:04.700
is going to labor.

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Now the same, a similar idea is, look,

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if this blue section grows,

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consistently grows faster
than the green pie,

00:05:18.666 --> 00:05:20.860
then the percentage of
income that goes to capital

00:05:20.860 --> 00:05:22.550
is going to grow more and more and more,

00:05:22.550 --> 00:05:25.990
and because in capitalist market economies

00:05:25.990 --> 00:05:28.820
capital is also not evenly distributed,

00:05:28.820 --> 00:05:31.740
mainly because income is
not evenly distributed,

00:05:31.740 --> 00:05:34.400
because capital is not evenly distributed,

00:05:34.400 --> 00:05:36.496
that this would essentially lead.

00:05:36.496 --> 00:05:39.270
As more and more income goes to capital

00:05:39.270 --> 00:05:41.024
and that capital is
disproportionately owned

00:05:41.024 --> 00:05:44.790
by the upper decile of income or wealth,

00:05:44.790 --> 00:05:46.490
then you're going to,
it's essentially going

00:05:46.490 --> 00:05:49.540
to drive this phenomenon right over there.

00:05:49.540 --> 00:05:51.730
Now I wanna be very clear.

00:05:51.730 --> 00:05:54.730
This growth right over
here, you'll hear the term

00:05:54.730 --> 00:05:58.340
return on capital in
conjunction with Piketty's book

00:05:58.340 --> 00:06:01.990
where they compare the return
on capital to growth rates.

00:06:01.990 --> 00:06:05.060
This growth right over here
is not the return on capital.

00:06:05.060 --> 00:06:06.920
In order to know the return on capital,

00:06:06.920 --> 00:06:10.050
you have to know how much,
you need to know the income

00:06:10.050 --> 00:06:11.710
that the capital generated,
but you also have to know

00:06:11.710 --> 00:06:13.931
the value of that capital,
and here in this diagram,

00:06:13.931 --> 00:06:16.760
all I know is the income
that the capital generated,

00:06:16.760 --> 00:06:18.820
but I don't know the
value of that capital,

00:06:18.820 --> 00:06:20.960
so I can't calculate
the return on capital.

00:06:20.960 --> 00:06:22.890
This growth that I'm
showing right over here,

00:06:22.890 --> 00:06:25.660
maybe after a few years
this blue section grows

00:06:25.660 --> 00:06:28.300
to over here, while the green section,

00:06:28.300 --> 00:06:31.500
while the pie has grown
something like this,

00:06:31.500 --> 00:06:32.910
this growth right over here,

00:06:32.910 --> 00:06:37.910
you could view this as the
growth of income to capital,

00:06:38.750 --> 00:06:40.800
which isn't something
you hear a lot about.

00:06:40.800 --> 00:06:42.780
But this growth right over here,

00:06:42.780 --> 00:06:47.780
this growth, maybe this is
plus 5% for the total economy,

00:06:47.990 --> 00:06:50.470
this is the G that's often referred to.

00:06:50.470 --> 00:06:54.193
This is the total growth of the economy.


Review of revenue and cost graphs for a monopoly

WEBVTT
Kind: captions
Language: en

00:00:00.219 --> 00:00:01.890
- [Instructor] What I
want to do in this video

00:00:01.890 --> 00:00:04.230
is review a little bit
of what we've learned

00:00:04.230 --> 00:00:07.580
about monopolies and, in the process,

00:00:07.580 --> 00:00:08.840
get a better understanding for

00:00:08.840 --> 00:00:10.510
some of the graphical representations,

00:00:10.510 --> 00:00:11.970
which we have talked about in the past,

00:00:11.970 --> 00:00:15.370
but I wanna put it all
together in this video here.

00:00:15.370 --> 00:00:18.530
So let's say that the
industry that we are in,

00:00:18.530 --> 00:00:22.760
the demand curve looks
something like that.

00:00:22.760 --> 00:00:25.520
That is demand and I'm going to assume

00:00:25.520 --> 00:00:27.880
that it is a linear demand curve.

00:00:27.880 --> 00:00:30.070
This axis right here is dollars per unit.

00:00:30.070 --> 00:00:32.750
In the context of demand, that's price,

00:00:32.750 --> 00:00:34.890
and this is quantity over here.

00:00:34.890 --> 00:00:37.110
This little graph here,
we still have quantity

00:00:37.110 --> 00:00:38.380
in the horizontal axis,

00:00:38.380 --> 00:00:40.770
but the vertical axis isn't
just dollars per unit,

00:00:40.770 --> 00:00:43.340
it's absolute level of dollars.

00:00:43.340 --> 00:00:44.910
Over here we can actually plot

00:00:46.400 --> 00:00:50.753
total revenue as a function
of quantity, total revenue.

00:00:52.206 --> 00:00:54.530
Remember, we're assuming
we're the only producer here.

00:00:54.530 --> 00:00:56.290
We have a monopoly,

00:00:56.290 --> 00:00:58.990
we have a monopoly in this market.

00:00:58.990 --> 00:01:00.377
So if we pick a quantity,

00:01:00.377 --> 00:01:02.580
if we don't produce anything,

00:01:02.580 --> 00:01:04.320
we're not going to generate any revenue,

00:01:04.320 --> 00:01:07.120
so our total revenue will be zero.

00:01:07.120 --> 00:01:10.300
If we produce a bunch, but we
don't charge anything for it,

00:01:10.300 --> 00:01:12.050
and that's this point right over here,

00:01:12.050 --> 00:01:15.930
our total revenue will also be zero.

00:01:15.930 --> 00:01:17.260
We've done this in other videos,

00:01:17.260 --> 00:01:19.480
but then as we increase
quantity from this point,

00:01:19.480 --> 00:01:21.810
our total revenue will keep
going up and up and up.

00:01:21.810 --> 00:01:23.170
There'll be some maximum point

00:01:23.170 --> 00:01:25.020
and then it'll start going down again,

00:01:25.020 --> 00:01:28.840
so our total revenue would
look something like this.

00:01:28.840 --> 00:01:33.610
Total revenue would look something
like that, total revenue.

00:01:33.610 --> 00:01:36.220
And from the total
revenue, we can think about

00:01:36.220 --> 00:01:38.700
what the marginal revenue would look like.

00:01:38.700 --> 00:01:41.030
Remember, the marginal revenue just says

00:01:41.030 --> 00:01:43.670
if I increase my quantity by a little bit,

00:01:43.670 --> 00:01:46.500
how much am I increasing my total revenue?

00:01:46.500 --> 00:01:48.330
So that's essentially the slope,

00:01:48.330 --> 00:01:51.590
the slope of the total revenue
curve at any given point,

00:01:51.590 --> 00:01:54.450
or you can think of it as the
slope of the tangent line.

00:01:54.450 --> 00:01:56.050
We've seen before, when you start here,

00:01:56.050 --> 00:01:58.000
you have a very high, positive slope

00:01:58.000 --> 00:01:59.270
and we've seen in other videos

00:01:59.270 --> 00:02:01.950
it actually ends up being
the exact same value

00:02:01.950 --> 00:02:05.090
as where the demand curve
intersects the vertical axis

00:02:05.090 --> 00:02:06.000
right over there,

00:02:06.000 --> 00:02:07.200
but then it keeps going lower,

00:02:07.200 --> 00:02:10.320
the slope becomes a little less
deep, less deep, less deep.

00:02:10.320 --> 00:02:12.710
It's still positive, less deep, less deep,

00:02:12.710 --> 00:02:14.560
and then it becomes zero right over there

00:02:14.560 --> 00:02:16.490
and then it starts going negative.

00:02:16.490 --> 00:02:20.113
It becomes zero right at that quantity.

00:02:21.439 --> 00:02:24.730
The slope of this keeps
going down and down and down,

00:02:24.730 --> 00:02:26.190
it's positive, then it becomes zero,

00:02:26.190 --> 00:02:28.770
and then it actually becomes
negative and you see that here.

00:02:28.770 --> 00:02:31.130
Now it starts downward
sloping even more steep,

00:02:31.130 --> 00:02:33.983
even more steep, and even more steep.

00:02:34.850 --> 00:02:36.830
That's the revenue side of things.

00:02:36.830 --> 00:02:41.000
Let me label this, this is
our marginal revenue curve,

00:02:41.000 --> 00:02:43.250
slope of the total revenue.

00:02:43.250 --> 00:02:45.460
If we're gonna maximize profit,

00:02:45.460 --> 00:02:47.570
we need to think about
what our costs look like,

00:02:47.570 --> 00:02:50.360
so let me draw our total cost curve.

00:02:50.360 --> 00:02:53.180
And I will do it in magenta.

00:02:53.180 --> 00:02:56.380
Let's say our total costs
look something like this.

00:02:56.380 --> 00:02:59.890
Total cost looks something like that.

00:02:59.890 --> 00:03:01.610
Out here, where we have very few units,

00:03:01.610 --> 00:03:04.590
where we have zero units, all
of our costs are fixed costs.

00:03:04.590 --> 00:03:07.430
And then as we produce
more and more units,

00:03:07.430 --> 00:03:10.410
the variable costs start
piling on over there.

00:03:10.410 --> 00:03:12.360
Even from this diagram, you can actually

00:03:12.360 --> 00:03:14.830
start to visually see economic profit.

00:03:14.830 --> 00:03:19.710
Economic profit, and when
we're talking costs and profit

00:03:19.710 --> 00:03:23.120
in an economics class, like
this is kind of one, I guess,

00:03:23.120 --> 00:03:25.630
remember, you should view it
in terms of economic profit

00:03:25.630 --> 00:03:27.290
and when we're talking about total cost,

00:03:27.290 --> 00:03:29.180
we're talking about opportunity cost.

00:03:29.180 --> 00:03:33.260
So this is total opportunity cost,

00:03:33.260 --> 00:03:34.523
both the implicit,

00:03:36.180 --> 00:03:37.255
both the explicit,

00:03:37.255 --> 00:03:39.160
the ones that you're actually
paying money for explicitly

00:03:39.160 --> 00:03:40.920
and the implicit opportunity costs.

00:03:40.920 --> 00:03:42.810
Total opportunity costs,

00:03:42.810 --> 00:03:44.340
that's total opportunity cost

00:03:44.340 --> 00:03:46.310
and the difference between
your total revenue,

00:03:46.310 --> 00:03:49.990
so for a given quantity,
the difference between

00:03:49.990 --> 00:03:53.751
your total revenue and your
total opportunity cost,

00:03:53.751 --> 00:03:56.060
that gives you your economic profit.

00:03:56.060 --> 00:03:57.500
For this quantity right over here,

00:03:57.500 --> 00:03:59.500
your economic profit would be represented

00:03:59.500 --> 00:04:04.500
by the height of this little
bar between these two curves.

00:04:04.580 --> 00:04:06.560
But what we see what's going on is,

00:04:06.560 --> 00:04:08.040
as we increase the quantity over here,

00:04:08.040 --> 00:04:10.370
these curves are getting
further and further apart.

00:04:10.370 --> 00:04:12.945
That's because the green
curve, the total revenue,

00:04:12.945 --> 00:04:17.230
it's slope is larger
than this purple curve,

00:04:17.230 --> 00:04:19.820
which is total opportunity cost,

00:04:19.820 --> 00:04:21.560
or you could say it total cost.

00:04:21.560 --> 00:04:23.550
So we could go even further along,

00:04:23.550 --> 00:04:25.120
just the distance between the two curves

00:04:25.120 --> 00:04:28.940
gets bigger, bigger,
looks like it maxes out

00:04:28.940 --> 00:04:31.830
right around here someplace

00:04:31.830 --> 00:04:33.550
and then the two things start getting

00:04:33.550 --> 00:04:34.840
closer and closer together.

00:04:34.840 --> 00:04:38.080
This purple curve's slope is now larger

00:04:38.080 --> 00:04:39.490
than the orange curve's slope,

00:04:39.490 --> 00:04:42.380
so then they start getting
closer and closer together.

00:04:42.380 --> 00:04:44.170
If you were to just look at this graph,

00:04:44.170 --> 00:04:45.620
whatever the maximum distance

00:04:45.620 --> 00:04:46.810
between these two things are,

00:04:46.810 --> 00:04:51.810
it looks like it's about
there, right over here,

00:04:51.910 --> 00:04:54.450
that would be your
maximum economic profit.

00:04:54.450 --> 00:04:56.210
But we know we can also visualize it

00:04:56.210 --> 00:04:57.610
on this curve over here.

00:04:57.610 --> 00:05:00.650
And we can do that by
plotting our marginal cost.

00:05:00.650 --> 00:05:02.410
And remember, marginal costs,

00:05:02.410 --> 00:05:04.090
this is marginal revenue,

00:05:04.090 --> 00:05:07.030
is the slope of your total revenue curve.

00:05:07.030 --> 00:05:09.380
Marginal cost is the slope,

00:05:09.380 --> 00:05:11.280
the instantaneous slope at any point

00:05:11.280 --> 00:05:13.360
of your total cost curve.

00:05:13.360 --> 00:05:15.820
So I will do that,
let's do that in yellow.

00:05:15.820 --> 00:05:18.180
Right over here, you have a zero slope,

00:05:18.180 --> 00:05:19.320
or pretty close to zero,

00:05:19.320 --> 00:05:20.870
at least the way I drew it over there.

00:05:20.870 --> 00:05:23.140
So your marginal cost is going to be

00:05:23.140 --> 00:05:25.160
pretty close to zero right over there.

00:05:25.160 --> 00:05:27.597
And then we see this slope
keeps increasing and increasing

00:05:27.597 --> 00:05:30.290
and increasing and so our
marginal cost will keep

00:05:30.290 --> 00:05:32.210
increasing, increasing, and increasing,

00:05:32.210 --> 00:05:34.590
so it will look something like that.

00:05:34.590 --> 00:05:37.682
That is our marginal cost curve.

00:05:37.682 --> 00:05:40.820
If we pick a quantity and if we find

00:05:40.820 --> 00:05:42.240
that the marginal cost over here,

00:05:42.240 --> 00:05:44.940
I don't know, let's say that
it's five dollars per unit,

00:05:44.940 --> 00:05:46.893
that literally means that the slope,

00:05:46.893 --> 00:05:51.150
that that same quantity, the
slope of our total cost curve,

00:05:51.150 --> 00:05:53.910
that the slope over there
would have to be five.

00:05:53.910 --> 00:05:55.440
That's what that is telling us.

00:05:55.440 --> 00:05:58.850
This is plotting the slope of
this curve right over here.

00:05:58.850 --> 00:06:00.800
And if we want to maximize profit,

00:06:00.800 --> 00:06:03.120
we already talked about how
you would do it visually

00:06:03.120 --> 00:06:05.650
on this curve, we can do it over here.

00:06:05.650 --> 00:06:07.250
Well, right over here, as we produce,

00:06:07.250 --> 00:06:10.340
if we start from producing
nothing to producing something,

00:06:10.340 --> 00:06:11.714
for each incremental unit,

00:06:11.714 --> 00:06:14.350
the incremental revenue we get on that

00:06:14.350 --> 00:06:16.300
is much higher than the incremental cost.

00:06:16.300 --> 00:06:17.520
So, hey, we should produce it

00:06:17.520 --> 00:06:19.030
because we're gonna get profit there.

00:06:19.030 --> 00:06:21.010
We could keep producing
because we're gonna get profit

00:06:21.010 --> 00:06:22.870
on each of these incremental units,

00:06:22.870 --> 00:06:24.760
so we'll keep doing it,
we'll keep doing it,

00:06:24.760 --> 00:06:27.520
we'll keep doing it,
until the marginal revenue

00:06:27.520 --> 00:06:29.260
is equal to the marginal cost.

00:06:29.260 --> 00:06:30.930
At that point, it doesn't make sense

00:06:30.930 --> 00:06:32.100
for us to produce anymore.

00:06:32.100 --> 00:06:34.770
If we produce an extra
unit past that point,

00:06:34.770 --> 00:06:37.670
on that unit our cost will
be higher than our revenue,

00:06:37.670 --> 00:06:40.360
so what will eat into our economic profit.

00:06:40.360 --> 00:06:43.370
So this right over here is
where we max the quantity,

00:06:43.370 --> 00:06:44.803
which we maximize profit.

00:06:44.803 --> 00:06:47.640
When we see it, we see
it right over there.

00:06:47.640 --> 00:06:49.750
The way I drew it, luckily, it looks like

00:06:49.750 --> 00:06:52.950
that is the maximum point
between those two curves as well,

00:06:52.950 --> 00:06:54.350
and it makes sense.

00:06:54.350 --> 00:06:56.590
Before this point, when marginal revenue

00:06:56.590 --> 00:06:58.680
is higher than marginal cost,

00:06:58.680 --> 00:07:01.950
that means that the slope
of the total revenue curve

00:07:01.950 --> 00:07:05.140
is larger than the slope
of the total cost curve,

00:07:05.140 --> 00:07:07.550
so they're getting
further and further apart.

00:07:07.550 --> 00:07:10.360
After this point, and right at that point

00:07:10.360 --> 00:07:11.510
their slopes are the same,

00:07:11.510 --> 00:07:14.160
so the slopes are going to
be the same right over there,

00:07:14.160 --> 00:07:15.940
and then after that point,

00:07:15.940 --> 00:07:17.917
the slope of the marginal cost curve,

00:07:17.917 --> 00:07:20.080
sorry, the marginal cost is high,

00:07:20.080 --> 00:07:23.110
which tells us the slope of
the total cost curve is higher,

00:07:23.110 --> 00:07:27.120
than the slope of the total revenue curve.

00:07:27.120 --> 00:07:28.990
And so they're gonna get
closer and closer together

00:07:28.990 --> 00:07:31.047
and this distance gets squinched apart.

00:07:31.047 --> 00:07:33.800
That is where you maximize profit.

00:07:33.800 --> 00:07:36.850
And if you wanted to
visualize the actual profit,

00:07:36.850 --> 00:07:38.020
on this graph over here,

00:07:38.020 --> 00:07:39.740
we cannot obviously visualize it here

00:07:39.740 --> 00:07:42.000
as the distance between these two curves.

00:07:42.000 --> 00:07:43.920
If you want to visualize it over here,

00:07:43.920 --> 00:07:48.270
we would have to plot our
average total cost curve.

00:07:48.270 --> 00:07:49.440
And essentially, what you're doing is

00:07:49.440 --> 00:07:51.080
you're just taking this total cost curve

00:07:51.080 --> 00:07:52.860
and you're not just taking
the slope at any point,

00:07:52.860 --> 00:07:54.370
that's the marginal cost,

00:07:54.370 --> 00:07:56.320
instead you're just dividing
it by the quantities.

00:07:56.320 --> 00:07:57.880
So if you take this total cost curve,

00:07:57.880 --> 00:07:59.100
you take this value and you divide it by

00:07:59.100 --> 00:08:01.050
very, very, very low quantity,

00:08:01.050 --> 00:08:03.470
you're going to get a very,
very, very, very large number.

00:08:03.470 --> 00:08:05.490
You can imagine, as you're
spreading your fixed costs

00:08:05.490 --> 00:08:07.870
amongst a very small quantity,

00:08:07.870 --> 00:08:09.420
so you're gonna get a very large number.

00:08:09.420 --> 00:08:12.220
Then, as you produce
more and more and more,

00:08:12.220 --> 00:08:14.550
your average total costs go down,

00:08:14.550 --> 00:08:18.130
but then your variable
costs start picking up

00:08:18.130 --> 00:08:21.210
and your average total costs
might look something like that.

00:08:21.210 --> 00:08:23.630
Average total costs.

00:08:23.630 --> 00:08:25.863
And so, if you wanna know your profit

00:08:25.863 --> 00:08:28.520
that you have maximized from
this graph right over here,

00:08:28.520 --> 00:08:31.410
you say this is the quantity
that maximizes my profit,

00:08:31.410 --> 00:08:33.800
marginal revenue is
equal to marginal costs,

00:08:33.800 --> 00:08:36.258
the price that I can get in
the market for that quantity,

00:08:36.258 --> 00:08:39.720
you go up to your demand
curve and it gives you,

00:08:39.720 --> 00:08:43.710
this is the price that you
will get for that quantity

00:08:43.710 --> 00:08:47.850
and so that is, on a per unit basis,

00:08:47.850 --> 00:08:50.060
that is the revenue that you will get.

00:08:50.060 --> 00:08:52.640
You can view price is equal to,

00:08:52.640 --> 00:08:55.390
price is the same thing as revenue,

00:08:55.390 --> 00:08:57.383
revenue per unit.

00:08:58.320 --> 00:09:01.030
So on a per unit basis, this
is the revenue you're getting,

00:09:01.030 --> 00:09:04.640
and on a per unit basis,
this is your average cost,

00:09:04.640 --> 00:09:05.880
this is average total costs.

00:09:05.880 --> 00:09:09.100
This is taking all your costs
and dividing it by units.

00:09:09.100 --> 00:09:11.230
On an average, per unit basis,

00:09:11.230 --> 00:09:13.450
this is going to be your economic profit.

00:09:13.450 --> 00:09:16.710
On a per unit basis, and
if you wanted to find your

00:09:16.710 --> 00:09:18.280
actual economic profit,

00:09:18.280 --> 00:09:21.560
you would have to multiply it
by the total number of units.

00:09:21.560 --> 00:09:24.290
So you would, essentially, have the area

00:09:24.290 --> 00:09:26.140
of this rectangle right over here.

00:09:26.140 --> 00:09:29.000
This is your per unit
average economic profit

00:09:29.000 --> 00:09:30.810
and so your total economic profit

00:09:30.810 --> 00:09:34.900
is going to be quantity
times profit per unit

00:09:34.900 --> 00:09:37.697
and so this right over
here is economic profit,

00:09:38.960 --> 00:09:40.990
or maybe I should call it
the total economic profit.

00:09:40.990 --> 00:09:41.823
Let me write it out,

00:09:41.823 --> 00:09:42.656
total

00:09:43.722 --> 00:09:46.010
economic

00:09:46.010 --> 00:09:46.950
profit.

00:09:46.950 --> 00:09:49.080
And the area of that rectangle

00:09:49.080 --> 00:09:51.420
should be the same thing as the height

00:09:51.420 --> 00:09:54.970
of this right over here.

00:09:54.970 --> 00:09:56.480
The only reason, and we can maintain

00:09:56.480 --> 00:09:57.840
this is a sustainable scenario

00:09:57.840 --> 00:09:59.220
because we have a monopoly.

00:09:59.220 --> 00:10:00.320
No one else can enter.

00:10:00.320 --> 00:10:01.570
If this was not a monopoly,

00:10:01.570 --> 00:10:03.730
if there were no barriers to entry,

00:10:03.730 --> 00:10:06.240
then other people say hey,
there's economic profit there,

00:10:06.240 --> 00:10:07.865
that means that there's an incentive

00:10:07.865 --> 00:10:10.570
for me to put those
same resources together

00:10:10.570 --> 00:10:12.476
and try to compete
because I'm going to get

00:10:12.476 --> 00:10:16.170
better returns than my opportunity costs

00:10:16.170 --> 00:10:20.623
than my alternatives is a
good way to think about it.


Change in expected future prices and demand

WEBVTT
Kind: captions
Language: en

00:00:00.590 --> 00:00:02.490
- [Instructor] We've been
talking about the law of demand

00:00:02.490 --> 00:00:05.790
and how if we hold all else
equal, a change in price,

00:00:05.790 --> 00:00:08.910
if price goes up, the
quantity demanded goes down,

00:00:08.910 --> 00:00:11.230
and if price goes down, the
quantity demanded goes up.

00:00:11.230 --> 00:00:14.760
So if you hold all else
equal, ceteris paribus,

00:00:14.760 --> 00:00:18.370
we are just moving along this
curve depending on what price.

00:00:18.370 --> 00:00:20.470
But what we started talking
about is what happens

00:00:20.470 --> 00:00:22.310
when you change some of those things

00:00:22.310 --> 00:00:23.700
that we have been holding equal,

00:00:23.700 --> 00:00:24.980
how does that change demand?

00:00:24.980 --> 00:00:27.570
In the last video, we
talked about the price

00:00:27.570 --> 00:00:30.800
of related goods, price of related goods.

00:00:30.800 --> 00:00:33.110
And if the price of related goods change,

00:00:33.110 --> 00:00:36.900
both complements and substitutes,
how that might change the,

00:00:36.900 --> 00:00:39.510
how that might increase
or decrease demand,

00:00:39.510 --> 00:00:42.710
the entire curve, not just
one particular scenario.

00:00:42.710 --> 00:00:46.160
Now let's talk about
another one of those factors

00:00:46.160 --> 00:00:47.560
that we've been holding constant,

00:00:47.560 --> 00:00:49.880
and think about how that
would change demand,

00:00:49.880 --> 00:00:52.800
the entire curve, if
we were to change that,

00:00:52.800 --> 00:00:57.110
and that's expectations of future prices.

00:00:57.110 --> 00:00:58.330
I'll do that in this green.

00:00:58.330 --> 00:01:03.330
So expectations, expectations
of future prices,

00:01:04.130 --> 00:01:08.340
of future, future prices.

00:01:08.340 --> 00:01:12.030
So let's say that, let's
talk about a first scenario

00:01:12.030 --> 00:01:15.180
right over here, where,
let's say that this curve,

00:01:15.180 --> 00:01:18.040
people didn't expect prices
to change for my ebook.

00:01:18.040 --> 00:01:20.691
And now, all of a sudden, people expect,

00:01:20.691 --> 00:01:23.490
there's a change in expectation,
now all of a sudden,

00:01:23.490 --> 00:01:26.580
they expect the prices
to go up going forward.

00:01:26.580 --> 00:01:31.580
So now, now, now expect,
expect the future price,

00:01:32.950 --> 00:01:37.713
the future price to go up.

00:01:38.720 --> 00:01:40.040
What's going to happen?

00:01:40.040 --> 00:01:42.210
If you expect the future price to go up,

00:01:42.210 --> 00:01:46.240
and the good or the product
in question is something

00:01:46.240 --> 00:01:48.320
that you can store, well, and depending on

00:01:48.320 --> 00:01:49.440
how much you expect it to go up,

00:01:49.440 --> 00:01:51.230
you're probably more likely to buy it now,

00:01:51.230 --> 00:01:53.530
buy it before the price goes up.

00:01:53.530 --> 00:01:56.320
So regardless of what point
on this curve we're at,

00:01:56.320 --> 00:01:57.620
regardless of the price point,

00:01:57.620 --> 00:02:00.180
at any one of those
price points, people now,

00:02:00.180 --> 00:02:02.680
because they want to, instead
of buying it later they want

00:02:02.680 --> 00:02:06.280
to buy it now, they are more,
the current demand will go up

00:02:06.280 --> 00:02:07.820
at any of these price points.

00:02:07.820 --> 00:02:09.790
So at $2, more people will want to buy it

00:02:09.790 --> 00:02:10.960
'cause they think it's gonna go up.

00:02:10.960 --> 00:02:12.520
At $4, more people will want to buy it

00:02:12.520 --> 00:02:13.910
'cause they think it's gonna go up.

00:02:13.910 --> 00:02:17.090
At any of these price points,
because now there's an,

00:02:17.090 --> 00:02:19.160
the expectations have
gone from being neutral

00:02:19.160 --> 00:02:21.170
to now expecting prices to go up,

00:02:21.170 --> 00:02:24.060
it will shift the entire
curve to the right.

00:02:24.060 --> 00:02:27.080
So this will shift the
entire curve to the right.

00:02:27.080 --> 00:02:30.170
So this right over here is scenario one.

00:02:30.170 --> 00:02:31.900
And it depends how much
this changes to say

00:02:31.900 --> 00:02:33.370
how much this shifts to the right.

00:02:33.370 --> 00:02:36.710
This is just a general
idea, this is scenario one.

00:02:36.710 --> 00:02:39.020
And the shifting of the entire curve,

00:02:39.020 --> 00:02:41.210
you could say they increased demand.

00:02:41.210 --> 00:02:43.800
So this is literally demand increasing,

00:02:43.800 --> 00:02:47.400
demand, demand increased.

00:02:47.400 --> 00:02:49.190
And when we talk about demand, remember,

00:02:49.190 --> 00:02:51.860
and you're probably
tired of me saying this,

00:02:51.860 --> 00:02:53.740
I'm not talking about
a particular quantity.

00:02:53.740 --> 00:02:56.770
I'm talking about the entire
curve shifting to the right

00:02:56.770 --> 00:02:59.520
because people expect
future prices to go up,

00:02:59.520 --> 00:03:01.320
so the current demand went up,

00:03:01.320 --> 00:03:04.610
the current demand curve
shifted to the right.

00:03:04.610 --> 00:03:07.040
And now we can just take
the other side of that.

00:03:07.040 --> 00:03:10.150
Imagine what happens in scenario two.

00:03:10.150 --> 00:03:12.840
Before people were neutral,
that was our curve right there.

00:03:12.840 --> 00:03:14.280
They didn't have any opinion about

00:03:14.280 --> 00:03:16.030
whether future prices
were gonna go up or down,

00:03:16.030 --> 00:03:18.210
or maybe they just assumed
they were gonna stay the same.

00:03:18.210 --> 00:03:21.270
And now they expect
future prices to go down.

00:03:21.270 --> 00:03:26.270
Now expect future prices,
future prices, to go down.

00:03:30.060 --> 00:03:31.260
And this is something that happens

00:03:31.260 --> 00:03:33.730
in consumer electronics
all the time, you see,

00:03:33.730 --> 00:03:37.250
whenever you buy a laptop or
any type of electronic device,

00:03:37.250 --> 00:03:39.800
we now assume that the
prices will go down.

00:03:39.800 --> 00:03:43.070
Now what we're talking about
is a change in expectations.

00:03:43.070 --> 00:03:45.210
So you're going from neutrality,

00:03:45.210 --> 00:03:47.440
or let's say you're going from,
you expect them to go down,

00:03:47.440 --> 00:03:49.360
but now you expect them
to go down even faster.

00:03:49.360 --> 00:03:50.790
And if all of a sudden
you expect them to go down

00:03:50.790 --> 00:03:54.250
even faster, you're even
less likely to buy them now.

00:03:54.250 --> 00:03:56.710
So if you expect, if before
you thought prices were going

00:03:56.710 --> 00:04:00.490
to be roughly constant, and
now you expect them to go down,

00:04:00.490 --> 00:04:02.980
now you're gonna say, well,
hey, at any given price point,

00:04:02.980 --> 00:04:04.940
why don't I just hold off a little bit

00:04:04.940 --> 00:04:06.660
and wait a little bit?

00:04:06.660 --> 00:04:08.860
So it's going to lower demand.

00:04:08.860 --> 00:04:13.390
So in this scenario, the whole
curve will shift to the left.

00:04:13.390 --> 00:04:16.440
At any given price point, the
quantity demanded will go down

00:04:16.440 --> 00:04:17.770
at any point in that curve.

00:04:17.770 --> 00:04:22.100
And so, the entire demand curve
will be shifted to the left.

00:04:22.100 --> 00:04:25.930
So because of scenario two, demand,

00:04:25.930 --> 00:04:29.370
demand was decreased,

00:04:29.370 --> 00:04:32.433
demand was decreased.


Socially efficient and inefficient outcomes

WEBVTT
Kind: captions
Language: en

00:00:00.210 --> 00:00:04.020
- [Sal] Let's study the
market for soda a little bit.

00:00:04.020 --> 00:00:07.200
And so, we're going to
draw our traditional axes,

00:00:07.200 --> 00:00:12.143
so that is price, and that is quantity.

00:00:13.490 --> 00:00:17.430
And we have seen our classic
supply and demand curves.

00:00:17.430 --> 00:00:20.770
So, this could be our
upward-sloping supply curve

00:00:20.770 --> 00:00:21.860
at a low price.

00:00:21.860 --> 00:00:23.510
Not a lotta people wanna produce soda,

00:00:23.510 --> 00:00:24.540
but as price goes higher,

00:00:24.540 --> 00:00:26.130
more and more people
would wanna produce it.

00:00:26.130 --> 00:00:28.850
And we could also view that
as a marginal cost curve.

00:00:28.850 --> 00:00:31.430
That first unit might be
quite easy to produce,

00:00:31.430 --> 00:00:33.510
but then it gets a little
bit more and more expensive

00:00:33.510 --> 00:00:35.560
or costly to produce as
you have to hire and train

00:00:35.560 --> 00:00:38.220
more people and get real
estate for your factories.

00:00:38.220 --> 00:00:41.030
So, you could also view this
as a marginal cost curve.

00:00:41.030 --> 00:00:43.310
And then, on the demand side,

00:00:43.310 --> 00:00:46.230
we have our classic downward-sloping curve

00:00:46.230 --> 00:00:47.063
at a high price.

00:00:47.063 --> 00:00:48.970
Not a lotta people are
gonna want the soda.

00:00:48.970 --> 00:00:51.300
But then, as price gets lower,

00:00:51.300 --> 00:00:52.960
a lot more people are gonna want the soda.

00:00:52.960 --> 00:00:54.470
So, this is our demand curve,

00:00:54.470 --> 00:00:57.230
which we could also view as
a marginal benefit curve.

00:00:57.230 --> 00:00:58.840
That first unit of soda,

00:00:58.840 --> 00:01:00.840
someone's going to get
a huge benefit for it,

00:01:00.840 --> 00:01:03.170
and so they have a high
willingness to pay.

00:01:03.170 --> 00:01:05.330
And then every incremental unit,

00:01:05.330 --> 00:01:07.120
people might just get a
little bit less benefit,

00:01:07.120 --> 00:01:10.300
and so they have a little
bit less willingness to pay,

00:01:10.300 --> 00:01:12.010
which makes this downward sloping.

00:01:12.010 --> 00:01:13.610
And so, we have our,

00:01:13.610 --> 00:01:15.930
this, we could also view as
a marginal benefit curve.

00:01:15.930 --> 00:01:19.180
And we have, and this is all review,

00:01:19.180 --> 00:01:21.700
you would have your equilibrium quantity

00:01:21.700 --> 00:01:25.660
that the market would produce
and the equilibrium price.

00:01:25.660 --> 00:01:27.850
But now, I'm going to introduce a new idea

00:01:27.850 --> 00:01:29.670
because everything we talked about here,

00:01:29.670 --> 00:01:31.530
the marginal benefit and the cost,

00:01:31.530 --> 00:01:33.930
this was just the marginal private benefit

00:01:33.930 --> 00:01:35.810
and the marginal private cost.

00:01:35.810 --> 00:01:39.020
It's not factoring in
society's benefits and costs.

00:01:39.020 --> 00:01:41.110
And so, let me relabel this a little bit.

00:01:41.110 --> 00:01:42.860
Instead of just saying marginal benefit,

00:01:42.860 --> 00:01:46.000
I'm gonna call this the
marginal private benefit.

00:01:46.000 --> 00:01:48.080
And instead of marginal cost,

00:01:48.080 --> 00:01:51.900
I'm going to call this
the marginal private cost.

00:01:51.900 --> 00:01:54.210
And this is the equilibrium price

00:01:54.210 --> 00:01:56.010
we would get to if we just factored

00:01:56.010 --> 00:01:57.930
in the private the costs and benefits.

00:01:57.930 --> 00:01:59.850
And this is the equilibrium quantity

00:01:59.850 --> 00:02:03.090
if we just factored in the
private costs and benefits.

00:02:03.090 --> 00:02:04.670
And so, I know what you're thinking,

00:02:04.670 --> 00:02:06.840
so that's nice, Sal, but how do we

00:02:06.840 --> 00:02:10.390
factor in the social benefits or costs?

00:02:10.390 --> 00:02:12.650
Well, for something like soda,

00:02:12.650 --> 00:02:15.890
you could have some negative social costs.

00:02:15.890 --> 00:02:18.490
And when you have negative social costs,

00:02:18.490 --> 00:02:21.070
you would call that a
negative externality.

00:02:21.070 --> 00:02:24.470
So, there are some negative externalities

00:02:24.470 --> 00:02:26.490
when you are thinking about soda.

00:02:26.490 --> 00:02:29.320
It could be that the cans cause pollution

00:02:29.320 --> 00:02:31.300
that has to be cleaned up by society.

00:02:31.300 --> 00:02:33.460
It could be that all
that sugar or corn syrup

00:02:33.460 --> 00:02:34.760
inside of people's bloodstream

00:02:34.760 --> 00:02:38.720
gives 'em diabetes or decays their teeth.

00:02:38.720 --> 00:02:40.880
And society's going to
have to pay for it somehow.

00:02:40.880 --> 00:02:43.270
And so, another way to think about it is

00:02:43.270 --> 00:02:45.380
we could add those negative externalities

00:02:45.380 --> 00:02:47.330
to the marginal private cost,

00:02:47.330 --> 00:02:50.850
and we could get a
marginal social cost curve.

00:02:50.850 --> 00:02:51.940
And so, let me do that.

00:02:51.940 --> 00:02:54.800
So, if we add the negative externalities,

00:02:54.800 --> 00:02:57.780
we get a marginal social cost curve.

00:02:57.780 --> 00:03:00.630
So, this factors in the
negative externalities.

00:03:00.630 --> 00:03:03.270
So, I'll call this the
marginal social cost.

00:03:03.270 --> 00:03:04.830
And let's say, for a soda,

00:03:04.830 --> 00:03:06.770
the private benefit, just for simplicity,

00:03:06.770 --> 00:03:09.500
is equal to the social
benefit on the margin.

00:03:09.500 --> 00:03:11.220
So, I'll say this is the same thing

00:03:11.220 --> 00:03:15.500
as the marginal social benefit curve.

00:03:15.500 --> 00:03:18.070
But now, if you think about it
form society's point of view,

00:03:18.070 --> 00:03:21.210
what is the optimal price and quantity?

00:03:21.210 --> 00:03:24.560
Well, then you wanna think
about where marginal social cost

00:03:24.560 --> 00:03:28.380
is equal to marginal social benefit,

00:03:28.380 --> 00:03:30.820
because if you produce,
you wanna keep producing

00:03:30.820 --> 00:03:32.270
as long as the social benefit

00:03:32.270 --> 00:03:34.130
is higher than the social cost.

00:03:34.130 --> 00:03:36.050
But then, when the social cost is higher

00:03:36.050 --> 00:03:38.040
than the social benefit,
well, then that's not good.

00:03:38.040 --> 00:03:40.090
Then you're going to
create negative benefit,

00:03:40.090 --> 00:03:42.840
or harm, to society.

00:03:42.840 --> 00:03:46.740
So, it'd be rational to
produce up to this quantity,

00:03:46.740 --> 00:03:49.060
this quantity right over here.

00:03:49.060 --> 00:03:50.950
So, this is the optimal quantity

00:03:50.950 --> 00:03:52.420
from a societal point of view.

00:03:52.420 --> 00:03:54.860
And this would be the optimal price

00:03:54.860 --> 00:03:56.720
from a societal point of view.

00:03:56.720 --> 00:03:58.360
But if you just let the private markets

00:03:58.360 --> 00:04:01.310
happen as they are, what happens?

00:04:01.310 --> 00:04:03.150
Well, then you're overproducing

00:04:03.150 --> 00:04:05.090
from a societal point of view.

00:04:05.090 --> 00:04:08.030
And if you think about it
from a societal point of view,

00:04:08.030 --> 00:04:09.300
this is what is optimal,

00:04:09.300 --> 00:04:11.160
but you produce all this quantity

00:04:11.160 --> 00:04:13.320
where the marginal social cost is higher

00:04:13.320 --> 00:04:15.230
than the marginal social benefit.

00:04:15.230 --> 00:04:18.810
And so, all of this is going to take away

00:04:18.810 --> 00:04:23.400
from society's benefit, from
the total surplus for society.

00:04:23.400 --> 00:04:28.080
And so, this is going to
create deadweight loss

00:04:28.080 --> 00:04:30.740
because these quantities are different.

00:04:30.740 --> 00:04:32.660
Now, we could also think about a scenario

00:04:32.660 --> 00:04:34.460
with positive externalities.

00:04:34.460 --> 00:04:37.463
Let's imagine the exercise,

00:04:39.231 --> 00:04:43.610
let's say the, I don't know,
exercise equipment market,

00:04:43.610 --> 00:04:48.010
exercise equipment market.

00:04:48.010 --> 00:04:50.730
We could draw similar curves.

00:04:50.730 --> 00:04:55.010
So, here, we have quantity,

00:04:55.010 --> 00:04:56.533
we have price,

00:04:57.740 --> 00:05:01.420
we have our marginal
private benefit curve,

00:05:01.420 --> 00:05:03.020
which would be our demand curve,

00:05:03.920 --> 00:05:07.120
so marginal private benefit,

00:05:07.120 --> 00:05:12.120
and we have our marginal
private cost curves,

00:05:12.140 --> 00:05:15.130
just like that, marginal private cost.

00:05:15.130 --> 00:05:16.910
And if we just let this market operate,

00:05:16.910 --> 00:05:19.380
just thinking about the
private cost and benefit,

00:05:19.380 --> 00:05:22.920
we would produce that quantity.

00:05:22.920 --> 00:05:24.640
And I'll say that's just considering

00:05:24.640 --> 00:05:26.320
the private side of things.

00:05:26.320 --> 00:05:29.200
And we would be at that price.

00:05:29.200 --> 00:05:32.400
But let's say that there's
a positive externality here.

00:05:32.400 --> 00:05:36.370
So, there's a positive externality.

00:05:36.370 --> 00:05:37.203
What is it?

00:05:37.203 --> 00:05:38.880
Well, the more exercise
equipment that's out there,

00:05:38.880 --> 00:05:40.660
the more people that are gonna exercise,

00:05:40.660 --> 00:05:42.110
it's going to make them happier,

00:05:42.110 --> 00:05:43.970
it's going to lower
their healthcare costs,

00:05:43.970 --> 00:05:48.180
and so we would wanna add that benefit,

00:05:48.180 --> 00:05:49.350
that positive externality,

00:05:49.350 --> 00:05:52.210
to the marginal private benefit curve

00:05:52.210 --> 00:05:54.190
to get the marginal social benefit curve.

00:05:54.190 --> 00:05:55.280
So, let's do that.

00:05:55.280 --> 00:05:56.820
So, we're gonna add to this,

00:05:56.820 --> 00:06:01.140
and we're going to get the
marginal social benefit curve,

00:06:01.140 --> 00:06:03.100
marginal social benefit.

00:06:03.100 --> 00:06:04.890
And let's say the marginal social cost

00:06:04.890 --> 00:06:08.380
is the same thing as the
marginal private cost curve,

00:06:08.380 --> 00:06:11.920
marginal social cost right over here.

00:06:11.920 --> 00:06:14.520
So, if you think about
what's optimal for society,

00:06:14.520 --> 00:06:17.160
society should want more
and more exercise equipment

00:06:17.160 --> 00:06:20.460
to be produced as long as
the marginal social benefit

00:06:20.460 --> 00:06:23.130
is higher than the marginal social cost.

00:06:23.130 --> 00:06:24.990
But as soon as the marginal
social cost gets higher

00:06:24.990 --> 00:06:26.230
than the marginal social benefit,

00:06:26.230 --> 00:06:29.660
then that makes no sense, that
would create negative value.

00:06:29.660 --> 00:06:33.580
And so, what's optimal for
society is to produce up to that.

00:06:33.580 --> 00:06:36.370
So, this is the quantity
that's optimal for society.

00:06:36.370 --> 00:06:39.860
This is the price that's
optimal for society.

00:06:39.860 --> 00:06:42.630
But if we just let the
private benefit and cost

00:06:42.630 --> 00:06:45.700
be what decides the
equilibrium price and quantity,

00:06:45.700 --> 00:06:47.530
well, we're only going
to produce this far.

00:06:47.530 --> 00:06:49.790
So, from a society point of view,

00:06:49.790 --> 00:06:52.340
we lost out on all of this quantity

00:06:52.340 --> 00:06:54.110
where the marginal social benefit

00:06:54.110 --> 00:06:56.400
is higher than the marginal social cost.

00:06:56.400 --> 00:07:00.330
So, you have this deadweight
loss right over there.

00:07:00.330 --> 00:07:02.330
So, the big takeaway here is,

00:07:02.330 --> 00:07:06.360
when you factor in negative externalities

00:07:06.360 --> 00:07:08.200
or positive externalities,

00:07:08.200 --> 00:07:11.440
you might discover
deadweight loss to society.

00:07:11.440 --> 00:07:12.490
And so, an interesting question

00:07:12.490 --> 00:07:15.650
is to think about how
could society rectify that.

00:07:15.650 --> 00:07:18.250
And there are ways to start
to at least approach it.


A monopsonistic market for labor

WEBVTT
Kind: captions
Language: en

00:00:00.170 --> 00:00:02.140
- [Instructor] So let's
continue with our conversation

00:00:02.140 --> 00:00:05.820
around factors of production for a firm,

00:00:05.820 --> 00:00:07.740
and we're going to focus
on the labor market.

00:00:07.740 --> 00:00:11.560
And so we've already drawn
axes like this multiple times,

00:00:11.560 --> 00:00:15.290
where our horizontal axis,
this is the quantity,

00:00:15.290 --> 00:00:19.260
quantity of labor that's
being employed by a firm.

00:00:19.260 --> 00:00:24.260
And then the vertical axis,
this is our wage rate.

00:00:24.280 --> 00:00:27.140
And so this is, we're looking
at the economics for a firm.

00:00:27.140 --> 00:00:29.770
And we're looking at how much labor

00:00:29.770 --> 00:00:32.920
is it rational for this firm to employ?

00:00:32.920 --> 00:00:34.490
And we've talked about the marginal

00:00:34.490 --> 00:00:36.970
revenue product multiple times.

00:00:36.970 --> 00:00:40.370
This is a view of how much
incremental revenue can

00:00:40.370 --> 00:00:44.670
the firm get every time it
brings on one more labor unit?

00:00:44.670 --> 00:00:46.750
And we've talked about
that we typically see it

00:00:46.750 --> 00:00:48.610
like a downward-sloping line like this

00:00:48.610 --> 00:00:49.880
'cause you have diminishing returns.

00:00:49.880 --> 00:00:52.120
Every time you add one more labor unit,

00:00:52.120 --> 00:00:54.470
the marginal revenue product

00:00:54.470 --> 00:00:57.370
of that labor goes a little bit down,

00:00:57.370 --> 00:00:59.740
and so that's when you
have diminishing returns.

00:00:59.740 --> 00:01:01.020
So this is marginal revenue products,

00:01:01.020 --> 00:01:03.290
and I'll be very particular this time.

00:01:03.290 --> 00:01:04.160
This is of labor.

00:01:04.160 --> 00:01:06.000
We could do a similar
marginal revenue product

00:01:06.000 --> 00:01:09.440
of other factors like land or capital.

00:01:09.440 --> 00:01:12.770
Now, to change things up in this video,

00:01:12.770 --> 00:01:14.880
we're not just going to talk about a firm

00:01:14.880 --> 00:01:17.730
that operates in a perfectly
competitive labor market.

00:01:17.730 --> 00:01:20.710
If we did, then its marginal factor cost

00:01:20.710 --> 00:01:22.527
would be whatever the
market wage rate would be,

00:01:22.527 --> 00:01:24.730
and it would be a
horizontal line like this.

00:01:24.730 --> 00:01:28.150
So you would have a marginal
factor cost of labor.

00:01:28.150 --> 00:01:29.520
But we're not going to talk about a firm

00:01:29.520 --> 00:01:32.100
that's in a perfectly
competitive labor market.

00:01:32.100 --> 00:01:33.820
We're going to talk about a firm

00:01:33.820 --> 00:01:37.990
that is a monopsony
employer, a very fancy word.

00:01:37.990 --> 00:01:40.353
So it is a monopsony,

00:01:41.640 --> 00:01:44.450
not a monopoly, a monopsony.

00:01:44.450 --> 00:01:46.930
Now, what does a monopsony mean?

00:01:46.930 --> 00:01:48.830
Well, you could almost view it as

00:01:48.830 --> 00:01:51.580
the reverse of what a monopoly is.

00:01:51.580 --> 00:01:55.250
A monopoly is you have one seller,

00:01:55.250 --> 00:01:57.550
so one seller,

00:01:57.550 --> 00:01:59.640
and many buyers,

00:01:59.640 --> 00:02:03.090
so many,

00:02:03.090 --> 00:02:05.720
many buyers.

00:02:05.720 --> 00:02:08.270
So that is a monopoly,

00:02:08.270 --> 00:02:10.580
monopoly right over there.

00:02:10.580 --> 00:02:13.820
A monopsony is when you have

00:02:13.820 --> 00:02:16.090
one buyer,

00:02:16.090 --> 00:02:18.800
so one buyer,

00:02:18.800 --> 00:02:20.563
and many sellers.

00:02:21.830 --> 00:02:25.113
And so you have many,

00:02:26.380 --> 00:02:28.170
many sellers.

00:02:28.170 --> 00:02:31.720
So this right over here
is a monopsony firm,

00:02:31.720 --> 00:02:33.610
monopsony.

00:02:33.610 --> 00:02:35.020
And in the context that
we're talking about,

00:02:35.020 --> 00:02:36.520
we're talking about labor markets.

00:02:36.520 --> 00:02:38.070
So this one, instead of saying one buyer,

00:02:38.070 --> 00:02:40.010
you could say this is one buyer of labor.

00:02:40.010 --> 00:02:42.360
So you could say one employer,

00:02:42.360 --> 00:02:43.810
one employer.

00:02:43.810 --> 00:02:46.120
And the sellers of labors,

00:02:46.120 --> 00:02:50.140
well, a seller of labor, well,
these are many potential,

00:02:50.140 --> 00:02:52.250
potential workers,

00:02:52.250 --> 00:02:54.380
potential workers.

00:02:54.380 --> 00:02:56.330
And there is many real-world examples

00:02:56.330 --> 00:02:58.630
that approach monopsony employers.

00:02:58.630 --> 00:03:00.240
Let's say we're in a small town,

00:03:00.240 --> 00:03:02.710
and there's only one hospital,

00:03:02.710 --> 00:03:05.050
so they're going to be
the monopsony employers

00:03:05.050 --> 00:03:07.910
of healthcare workers, of, say, nurses.

00:03:07.910 --> 00:03:10.940
And so what's interesting
about a monopsony employer

00:03:10.940 --> 00:03:14.670
is they're not just going to
take whatever the wage rate is,

00:03:14.670 --> 00:03:18.800
they have to essentially,
they have a supply curve

00:03:18.800 --> 00:03:21.230
for labor in that market.

00:03:21.230 --> 00:03:23.503
And so, for example, in this market,

00:03:25.929 --> 00:03:27.550
when wages are low,

00:03:27.550 --> 00:03:30.110
there's going to be a low supply of labor.

00:03:30.110 --> 00:03:32.740
Not many people are going to
wanna work for that hospital.

00:03:32.740 --> 00:03:34.720
And then as wages go up,

00:03:34.720 --> 00:03:37.780
more and more and more
people are going to want

00:03:37.780 --> 00:03:40.850
to work for that monopsony employer.

00:03:40.850 --> 00:03:43.770
And so this is our labor,

00:03:43.770 --> 00:03:46.623
labor supply curve.

00:03:48.910 --> 00:03:49.930
Now, I'm gonna ask you a question.

00:03:49.930 --> 00:03:52.220
I'm gonna tell you right
now, it is a trick question.

00:03:52.220 --> 00:03:54.530
What is going to be the rational quantity

00:03:54.530 --> 00:03:57.180
for this firm to hire?

00:03:57.180 --> 00:03:59.010
Now, you might be tempted to say, well,

00:03:59.010 --> 00:04:00.490
it's just the same thing.

00:04:00.490 --> 00:04:02.850
We would just want to keep hiring

00:04:02.850 --> 00:04:05.470
as long as our marginal
revenue product of labor

00:04:05.470 --> 00:04:08.290
is higher than the cost of labor.

00:04:08.290 --> 00:04:10.640
And that would be true if you could afford

00:04:10.640 --> 00:04:13.270
to pay everyone a different rate.

00:04:13.270 --> 00:04:16.760
If this first unit of labor,
you can pay someone this much,

00:04:16.760 --> 00:04:18.040
and then everyone that you hire,

00:04:18.040 --> 00:04:19.280
you have to just pay
them a little bit more.

00:04:19.280 --> 00:04:21.120
But that's not the way
that it typically works.

00:04:21.120 --> 00:04:23.900
In the real world, you
often think about having to,

00:04:23.900 --> 00:04:27.880
whatever the wage is, if we
decide that this is the quantity

00:04:27.880 --> 00:04:29.950
of labor that we wanna bring on,

00:04:29.950 --> 00:04:33.720
you wouldn't pay this wage just
to that incremental person,

00:04:33.720 --> 00:04:36.940
you would have to pay
that wage to everyone.

00:04:36.940 --> 00:04:41.100
And so to think about what is
the rational quantity of labor

00:04:41.100 --> 00:04:44.020
to bring on for this firm,
we would need to think,

00:04:44.020 --> 00:04:46.120
we need to calculate or at least visualize

00:04:46.120 --> 00:04:48.340
what the marginal factor
cost of labor here,

00:04:48.340 --> 00:04:50.740
which is going to be different
than our labor supply curve.

00:04:50.740 --> 00:04:52.850
And to help us visualize that,

00:04:52.850 --> 00:04:55.090
let me set up a little table here.

00:04:55.090 --> 00:04:57.590
So I'm just gonna make up some numbers.

00:04:57.590 --> 00:05:01.210
So look, we're going to think
about the quantity of labor,

00:05:01.210 --> 00:05:03.940
so let's just go zero, one,

00:05:03.940 --> 00:05:06.970
two, three, four.

00:05:06.970 --> 00:05:09.780
And then let's think
about the price of labor.

00:05:09.780 --> 00:05:11.980
And so let's say when the
quantity of labor is one,

00:05:11.980 --> 00:05:14.170
the price of labor is three.

00:05:14.170 --> 00:05:16.450
And then it goes up as we,

00:05:16.450 --> 00:05:17.710
if we wanna hire more people,

00:05:17.710 --> 00:05:19.820
well, the price of labor goes up to four,

00:05:19.820 --> 00:05:22.420
goes up to five, goes
up to six, keeps going.

00:05:22.420 --> 00:05:25.940
And then what would be
the total cost of labor?

00:05:25.940 --> 00:05:30.453
So total labor cost,

00:05:31.670 --> 00:05:32.960
well, you could figure that out.

00:05:32.960 --> 00:05:36.040
If you hire one unit at $3 per unit,

00:05:36.040 --> 00:05:38.210
one times three is three.

00:05:38.210 --> 00:05:41.980
Two units at $4 per unit,
remember, you're going to have

00:05:41.980 --> 00:05:43.460
to pay everyone the same amount.

00:05:43.460 --> 00:05:46.020
So it's not like you can
just pay this first person $3

00:05:46.020 --> 00:05:47.680
and only the second person $4,

00:05:47.680 --> 00:05:49.530
in which case, this would be seven.

00:05:49.530 --> 00:05:50.470
But if you're going to hire two units,

00:05:50.470 --> 00:05:52.640
you have to pay everyone $4.

00:05:52.640 --> 00:05:55.870
So your total cost is
eight here, two times four.

00:05:55.870 --> 00:05:58.450
Three time five, your total cost is 15.

00:05:58.450 --> 00:06:01.550
Your total cost here is 24.

00:06:01.550 --> 00:06:02.960
And so now we could think about

00:06:02.960 --> 00:06:06.410
what is our marginal factor cost of labor?

00:06:06.410 --> 00:06:09.350
So when you bring on that
incremental unit of labor,

00:06:09.350 --> 00:06:12.800
how much incremental
cost are you taking on?

00:06:12.800 --> 00:06:15.090
Well, when you go from one to two units,

00:06:15.090 --> 00:06:17.550
your total cost goes from three to eight,

00:06:17.550 --> 00:06:21.810
so your marginal factor cost is five.

00:06:21.810 --> 00:06:23.860
This is plus five right over here.

00:06:23.860 --> 00:06:25.420
When you go from two to three,

00:06:25.420 --> 00:06:29.990
your marginal factor cost,
you went from eight to 15.

00:06:29.990 --> 00:06:33.670
So eight to 15, you went up by seven.

00:06:33.670 --> 00:06:34.810
And once again, this is because

00:06:34.810 --> 00:06:37.330
when you wanna hire more
people, you're going to have

00:06:37.330 --> 00:06:39.540
to pay more to track
those incremental people,

00:06:39.540 --> 00:06:41.800
but then you have to pay
that higher rate to everyone.

00:06:41.800 --> 00:06:44.620
And so you see that the
marginal factor cost of labor

00:06:44.620 --> 00:06:46.810
is going up twice as fast

00:06:46.810 --> 00:06:49.270
as our labor supply curve.

00:06:49.270 --> 00:06:50.290
Our labor supply curve,

00:06:50.290 --> 00:06:51.950
every incremental unit, we're adding one.

00:06:51.950 --> 00:06:54.360
Here, every incremental
unit, we're adding two.

00:06:54.360 --> 00:06:55.193
And we could see it again.

00:06:55.193 --> 00:06:57.880
To go from 15 to 24,

00:06:57.880 --> 00:06:59.440
you have to add nine,

00:06:59.440 --> 00:07:02.800
so our marginal factor
cost of labor is nine.

00:07:02.800 --> 00:07:04.770
And so looking at this as an example,

00:07:04.770 --> 00:07:08.430
you see that your marginal
factor cost of labor

00:07:08.430 --> 00:07:11.210
is going to go up at twice the slope

00:07:11.210 --> 00:07:13.200
of your labor supply curve.

00:07:13.200 --> 00:07:15.570
So your marginal factor cost of labor

00:07:15.570 --> 00:07:18.410
is going to look something like this.

00:07:18.410 --> 00:07:20.860
It's going to go up twice as fast,

00:07:20.860 --> 00:07:23.260
marginal factor cost of labor.

00:07:23.260 --> 00:07:24.850
And now this might be ringing a bell.

00:07:24.850 --> 00:07:27.340
This might seem like what
we studied in the past

00:07:27.340 --> 00:07:30.620
when we looked at a monopoly

00:07:30.620 --> 00:07:33.530
or an imperfect competitor firm.

00:07:33.530 --> 00:07:36.320
And we talked about the
demand for its goods,

00:07:36.320 --> 00:07:39.030
and we also talked about
its marginal revenue.

00:07:39.030 --> 00:07:40.890
And the marginal revenue curve

00:07:40.890 --> 00:07:44.530
had twice the negative
slope as the demand curve.

00:07:44.530 --> 00:07:47.810
And here, we see everything
just flipped over.

00:07:47.810 --> 00:07:51.520
Because we're now not talking
about revenue for the firm

00:07:51.520 --> 00:07:53.720
and marginal revenue for the firm,

00:07:53.720 --> 00:07:55.980
we are talking about costs for the firm.

00:07:55.980 --> 00:07:57.870
These are inputs for the firm.

00:07:57.870 --> 00:08:02.120
But now what would be
the rational wage rate?

00:08:02.120 --> 00:08:06.290
And what's the rational
quantity of labor for this firm?

00:08:06.290 --> 00:08:08.060
Well, now that we've done
the marginal analysis,

00:08:08.060 --> 00:08:09.780
we would see that it's
rational for the firm

00:08:09.780 --> 00:08:11.850
to keep bringing on more and more people

00:08:11.850 --> 00:08:14.640
as long as the marginal
revenue product of labor

00:08:14.640 --> 00:08:16.700
for each incremental unit is higher

00:08:16.700 --> 00:08:19.170
than the marginal factor cost of labor

00:08:19.170 --> 00:08:20.570
for each incremental unit.

00:08:20.570 --> 00:08:21.820
And so we'd keep hiring

00:08:21.820 --> 00:08:24.210
until you get to this
point right over here.

00:08:24.210 --> 00:08:27.710
So it would be rational for it to

00:08:27.710 --> 00:08:31.200
bring on this quantity of labor.

00:08:31.200 --> 00:08:34.360
And what would be the
wage that it would pay?

00:08:34.360 --> 00:08:36.870
Well, you might be tempted
to just go right over here

00:08:36.870 --> 00:08:39.030
and say it would pay this wage,

00:08:39.030 --> 00:08:41.420
but remember it doesn't
have to pay this wage.

00:08:41.420 --> 00:08:44.840
At this quantity of labor, the
labor supply curve tells us

00:08:44.840 --> 00:08:47.860
that the market wage
would be right over here.

00:08:47.860 --> 00:08:50.580
So it would be paying,

00:08:50.580 --> 00:08:53.410
it would be paying this wage.

00:08:53.410 --> 00:08:56.650
It would be paying this
wage right over here.

00:08:56.650 --> 00:08:57.780
So this is something for you

00:08:57.780 --> 00:09:00.000
to maybe ponder on a little bit more.

00:09:00.000 --> 00:09:01.440
But the big picture is,

00:09:01.440 --> 00:09:04.050
is when we're dealing
with a monopsony firm,

00:09:04.050 --> 00:09:06.960
so it is the only person
hiring in the market

00:09:06.960 --> 00:09:10.160
or something that's
approaching a monopsony firm,

00:09:10.160 --> 00:09:13.410
it's going to have its
own labor supply curve.

00:09:13.410 --> 00:09:14.680
And the way you think about

00:09:14.680 --> 00:09:17.660
what a rational quantity
for it to hire is,

00:09:17.660 --> 00:09:21.620
you would think about the
marginal factor cost of labor,

00:09:21.620 --> 00:09:23.660
which is going to go
up at twice the slope.

00:09:23.660 --> 00:09:26.630
And where that intersects
the marginal revenue product,

00:09:26.630 --> 00:09:28.300
well, that tells you the quantity,

00:09:28.300 --> 00:09:30.640
and then the labor supply
curve will tell you the wage

00:09:30.640 --> 00:09:32.373
for that quantity.


Cost minimizing choice of inputs

WEBVTT
Kind: captions
Language: en

00:00:00.090 --> 00:00:01.580
- [Instructor] We are
now going to continue

00:00:01.580 --> 00:00:04.250
our discussion of factor markets.

00:00:04.250 --> 00:00:05.950
And we're going to go beyond

00:00:05.950 --> 00:00:07.880
just thinking about labor as a factor.

00:00:07.880 --> 00:00:09.450
In fact, in this video,
we're going to start

00:00:09.450 --> 00:00:11.570
thinking about capital as well,

00:00:11.570 --> 00:00:14.700
which we know is another one
of the factors of production.

00:00:14.700 --> 00:00:16.500
But just as a little bit of review,

00:00:16.500 --> 00:00:19.790
we've already thought about
it from a firms perspective

00:00:19.790 --> 00:00:24.707
on what is the rational
amount of labor to hire

00:00:25.700 --> 00:00:29.000
based on the marginal
revenue product of labor

00:00:29.000 --> 00:00:31.470
and based on the marginal
factor cost of labor.

00:00:31.470 --> 00:00:36.470
So, in the horizontal axis,
we have the quantity of labor

00:00:37.270 --> 00:00:38.570
hired by the firm.

00:00:38.570 --> 00:00:42.550
And in the vertical axis,
you have the wage rate,

00:00:42.550 --> 00:00:46.200
wage rate, which you could
view as the price of labor.

00:00:46.200 --> 00:00:48.930
And we've seen this multiple times.

00:00:48.930 --> 00:00:51.530
You are likely to have a downward sloping

00:00:51.530 --> 00:00:55.490
marginal revenue product curve, MRP.

00:00:55.490 --> 00:00:56.870
And I'm going to be very specific

00:00:56.870 --> 00:01:01.630
that this one is the marginal
revenue product of labor.

00:01:01.630 --> 00:01:04.410
And then we have the
marginal factor cost curve.

00:01:04.410 --> 00:01:06.400
And if we're assuming that this firm

00:01:06.400 --> 00:01:09.470
is in a competitive, perfectly
competitive labor market,

00:01:09.470 --> 00:01:10.640
well, they're just going to have to pay

00:01:10.640 --> 00:01:13.060
whatever the wage is in the market.

00:01:13.060 --> 00:01:15.200
And so, that's why we have
a horizontal line there,

00:01:15.200 --> 00:01:19.400
so that's the marginal
factor cost of labor.

00:01:19.400 --> 00:01:21.340
And we've talked about multiple times

00:01:21.340 --> 00:01:24.710
that it's rational for
the firm to keep hiring

00:01:24.710 --> 00:01:28.210
as long as the marginal
revenue product of labor,

00:01:28.210 --> 00:01:30.800
as long as the incremental revenue

00:01:30.800 --> 00:01:33.190
that the firm gets for
each of those people

00:01:33.190 --> 00:01:35.620
or each of those units
of labor that they hire

00:01:35.620 --> 00:01:38.346
is higher than the incremental cost

00:01:38.346 --> 00:01:40.280
of each of those units of labor.

00:01:40.280 --> 00:01:43.970
And so, it'll keep hiring until
these two lines intersect.

00:01:43.970 --> 00:01:45.260
And so, it would be rational for it

00:01:45.260 --> 00:01:48.030
to hire that quantity of labor.

00:01:48.030 --> 00:01:49.890
I'll do this is the labor for the firm,

00:01:49.890 --> 00:01:51.260
and I'll put a little star over here,

00:01:51.260 --> 00:01:52.890
so that quantity of labor.

00:01:52.890 --> 00:01:56.710
And we can draw an
analogous thing for capital.

00:01:56.710 --> 00:02:00.060
So, this is how a firm
thinks about that input,

00:02:00.060 --> 00:02:01.900
how it thinks about labor.

00:02:01.900 --> 00:02:06.200
But we could also do
something similar for capital.

00:02:06.200 --> 00:02:08.480
Or we could do it for land as well.

00:02:08.480 --> 00:02:11.670
But hopefully, so this
is going to be the firm,

00:02:11.670 --> 00:02:14.530
the firm as you think about capital.

00:02:14.530 --> 00:02:19.300
And we'll see that they
have analogous axes.

00:02:19.300 --> 00:02:21.320
The horizontal axis right over here

00:02:21.320 --> 00:02:23.970
is going to be the quantity not of labor,

00:02:23.970 --> 00:02:27.100
but the quantity of capital.

00:02:27.100 --> 00:02:30.900
And then the vertical
axis, the price of capital,

00:02:30.900 --> 00:02:33.720
you could view that as the rent rate,

00:02:33.720 --> 00:02:35.300
rent rate, if you're thinking about maybe

00:02:35.300 --> 00:02:37.120
you're renting some type of machinery.

00:02:37.120 --> 00:02:38.760
And so, you will have your

00:02:38.760 --> 00:02:41.930
marginal revenue product of capital.

00:02:41.930 --> 00:02:44.350
We could still imagine that
you have diminishing returns,

00:02:44.350 --> 00:02:46.240
so that's why it's downward sloping,

00:02:46.240 --> 00:02:48.970
so marginal revenue product.

00:02:48.970 --> 00:02:52.550
And we typically use a K for capital,

00:02:52.550 --> 00:02:55.850
just so we don't get the C
confused with other things.

00:02:55.850 --> 00:02:58.270
And then we have our marginal factor cost,

00:02:58.270 --> 00:03:00.760
which is really just, and
we'll assume, once again,

00:03:00.760 --> 00:03:03.620
that this is a perfectly
competitive capital market,

00:03:03.620 --> 00:03:05.530
so you just have to pay
whatever the market rate

00:03:05.530 --> 00:03:07.640
for renting that capital is.

00:03:07.640 --> 00:03:10.550
And so, that would be the marginal

00:03:10.550 --> 00:03:12.690
factor cost of the capital.

00:03:12.690 --> 00:03:14.900
And so, once again, it makes sense

00:03:14.900 --> 00:03:18.030
to keep bringing on more
and more and more capital

00:03:18.030 --> 00:03:21.840
as long as the incremental
revenue that you get

00:03:21.840 --> 00:03:24.010
from each of those extra units of capital

00:03:24.010 --> 00:03:26.010
is higher than the cost of each

00:03:26.010 --> 00:03:27.670
of those extra units of capital.

00:03:27.670 --> 00:03:31.660
And so, here, it would
be rational for the firm,

00:03:31.660 --> 00:03:32.900
if we're just looking at the dimension

00:03:32.900 --> 00:03:35.250
of capital to product this much.

00:03:35.250 --> 00:03:37.610
So, this would be, actually, let me,

00:03:37.610 --> 00:03:41.240
this would be the capital,
the quantity of capital

00:03:41.240 --> 00:03:43.600
for the firm to employ.

00:03:43.600 --> 00:03:45.140
Now, an interesting question that might've

00:03:45.140 --> 00:03:46.450
already crossed your minds are,

00:03:46.450 --> 00:03:48.900
is that firms have a
certain amount of resources

00:03:48.900 --> 00:03:51.530
that they are going to think about,

00:03:51.530 --> 00:03:53.750
well, how much do I put in labor

00:03:53.750 --> 00:03:57.610
versus how much do I put into capital.

00:03:57.610 --> 00:04:00.738
So, they don't just think
about these dimensions

00:04:00.738 --> 00:04:04.530
of how much inputs of
these factors they want,

00:04:04.530 --> 00:04:07.560
they have to think about
them relative to each other.

00:04:07.560 --> 00:04:10.350
And to help us think through this,

00:04:10.350 --> 00:04:13.800
let's say that we are at
a certain level of output.

00:04:13.800 --> 00:04:16.200
So, let's say that our output right now,

00:04:16.200 --> 00:04:18.763
I don't know, our current output,

00:04:20.040 --> 00:04:21.050
our current

00:04:22.550 --> 00:04:23.383
output

00:04:24.320 --> 00:04:26.730
is, I'm just going to make up something,

00:04:26.730 --> 00:04:30.580
1,000 units per day.

00:04:30.580 --> 00:04:33.240
And at our current output,

00:04:33.240 --> 00:04:35.850
we know what the marginal product of labor

00:04:35.850 --> 00:04:38.360
and the marginal product of capital is.

00:04:38.360 --> 00:04:43.360
Let's say that we know that
our marginal product of labor

00:04:43.550 --> 00:04:45.300
at this output, remember it changes,

00:04:45.300 --> 00:04:46.700
as we have different output

00:04:46.700 --> 00:04:49.140
and we bring on more
labor or more capital,

00:04:49.140 --> 00:04:54.140
so our marginal product of
labor at that level is 90 units.

00:04:55.350 --> 00:04:56.370
So, another way to think about it,

00:04:56.370 --> 00:04:59.850
for every incremental
unit of labor we bring on,

00:04:59.850 --> 00:05:04.080
we're going to be able to
produce 90 more units of output,

00:05:04.080 --> 00:05:07.420
so this is, and then let's
say that the price of labor,

00:05:07.420 --> 00:05:12.127
which is the wage rate, is equal to $10,

00:05:12.127 --> 00:05:14.340
$10 per unit of labor.

00:05:14.340 --> 00:05:16.600
So, let me call this output units,

00:05:16.600 --> 00:05:18.640
output units.

00:05:18.640 --> 00:05:22.190
And let's say that the
marginal product of capital,

00:05:22.190 --> 00:05:23.930
let me do this in a different color,

00:05:23.930 --> 00:05:27.860
the marginal product of capital right now

00:05:27.860 --> 00:05:30.440
is 80 output units,

00:05:30.440 --> 00:05:31.273
output

00:05:32.200 --> 00:05:33.033
units.

00:05:33.033 --> 00:05:36.100
So, every unit of this factor of capital,

00:05:36.100 --> 00:05:39.890
we are able to produce an
incremental 80 output units.

00:05:39.890 --> 00:05:43.090
And let's say that the price of capital,

00:05:43.090 --> 00:05:46.103
which would be the rent, is equal to $5,

00:05:47.467 --> 00:05:51.060
$5 per input unit of the factor.

00:05:51.060 --> 00:05:56.060
So, right at this moment, if
I have an incremental dollar,

00:05:56.350 --> 00:05:59.850
would it be more rational
for me to add more labor,

00:05:59.850 --> 00:06:02.640
or would it be more rational
for me to add more capital?

00:06:02.640 --> 00:06:05.513
Pause this video and see
if you can figure that out.

00:06:06.780 --> 00:06:08.750
Well, to think about which
one is more rational,

00:06:08.750 --> 00:06:09.670
you just have to think about which one

00:06:09.670 --> 00:06:12.400
do I get more of a bang for my buck.

00:06:12.400 --> 00:06:15.950
So, per dollar, how many
output units do I get

00:06:15.950 --> 00:06:17.760
when I put a dollar into labor

00:06:17.760 --> 00:06:20.400
versus, per dollar, how
many output units do I get

00:06:20.400 --> 00:06:22.420
when I put that dollar into capital?

00:06:22.420 --> 00:06:25.000
So, let's do it first for labor.

00:06:25.000 --> 00:06:27.520
So, if you want your bang
for the buck, so to speak,

00:06:27.520 --> 00:06:29.230
you would just take your marginal,

00:06:29.230 --> 00:06:30.980
let me do this in a different color,

00:06:30.980 --> 00:06:32.520
if you want your bang for buck,

00:06:32.520 --> 00:06:35.360
you would just take your
marginal product of labor,

00:06:35.360 --> 00:06:38.180
so your output, and
divide it by the price.

00:06:38.180 --> 00:06:40.840
So, this is gonna tell
you output per dollar.

00:06:40.840 --> 00:06:45.721
And so, in this situation,
it's 90 output units,

00:06:45.721 --> 00:06:50.490
we could say widgets for a
general term for output units,

00:06:50.490 --> 00:06:54.270
output units, over $10,

00:06:54.270 --> 00:06:55.330
over $10.

00:06:55.330 --> 00:06:57.050
And so, this is going to be equal

00:06:57.050 --> 00:06:59.860
to nine output units per dollar.

00:06:59.860 --> 00:07:04.500
So, this is equal to nine output units

00:07:05.410 --> 00:07:07.350
per dollar.

00:07:07.350 --> 00:07:10.430
So, that's our measure
of our bang for our buck

00:07:10.430 --> 00:07:13.940
when we put an incremental
buck into labor.

00:07:13.940 --> 00:07:15.960
Now, what about for capital?

00:07:15.960 --> 00:07:18.900
Well, our marginal product of capital

00:07:18.900 --> 00:07:21.840
divided by the price of capital,

00:07:21.840 --> 00:07:24.300
right at this moment, remember it changes

00:07:24.300 --> 00:07:26.710
depending on our output level
and different combinations,

00:07:26.710 --> 00:07:31.200
is going to be equal to 80 output units

00:07:32.060 --> 00:07:33.313
divided by $5,

00:07:34.570 --> 00:07:39.570
which is equal to 16 output units

00:07:40.050 --> 00:07:42.010
per dollar.

00:07:42.010 --> 00:07:44.840
So, which one would I get
a better bang for my buck?

00:07:44.840 --> 00:07:46.820
Well, right at this moment,

00:07:46.820 --> 00:07:48.530
I'm getting a better bang for my buck

00:07:48.530 --> 00:07:51.380
from investing in capital.

00:07:51.380 --> 00:07:54.090
Every extra dollar I put,
I get 16 output units.

00:07:54.090 --> 00:07:55.720
So, it'd be rational for this firm

00:07:55.720 --> 00:07:58.820
that wants to maximize its
profit and reduce its cost,

00:07:58.820 --> 00:08:00.980
if it has an extra dollar to invest,

00:08:00.980 --> 00:08:03.270
it would put it into capital.

00:08:03.270 --> 00:08:05.450
And so, maybe it puts it into capital,

00:08:05.450 --> 00:08:07.340
and then it gets a little bit more output.

00:08:07.340 --> 00:08:09.290
And then the marginal product of capital

00:08:09.290 --> 00:08:10.510
is likely to go down.

00:08:10.510 --> 00:08:12.420
And so, you could imagine, at some point,

00:08:12.420 --> 00:08:14.120
these things might be equal,

00:08:14.120 --> 00:08:16.630
and then the firm might be
indifferent between the two.

00:08:16.630 --> 00:08:19.970
And then maybe, at some point,
if they kept adding capital,

00:08:19.970 --> 00:08:22.830
then maybe you get a better bang

00:08:22.830 --> 00:08:25.290
for your buck from the labor.

00:08:25.290 --> 00:08:28.010
In general, a firm would wanna keep

00:08:28.010 --> 00:08:29.320
investing in one or the other

00:08:29.320 --> 00:08:32.940
until these two things
are equal to each other.

00:08:32.940 --> 00:08:36.700
So, big picture, you would
look at the marginal product

00:08:36.700 --> 00:08:38.900
of the factor divided by
the price of the factor,

00:08:38.900 --> 00:08:40.610
and then you'd compare that
to the marginal product

00:08:40.610 --> 00:08:42.220
of the other factors divided by the price

00:08:42.220 --> 00:08:43.490
of those other factors.

00:08:43.490 --> 00:08:45.810
And whichever one has the
best bang for the buck,

00:08:45.810 --> 00:08:48.000
that's where it would be
rational to invest in.

00:08:48.000 --> 00:08:50.340
And then you have, in some ways, your,

00:08:50.340 --> 00:08:53.040
one way is a very efficient combination,

00:08:53.040 --> 00:08:56.030
is if you get to that point
that you're indifferent,

00:08:56.030 --> 00:08:58.870
when the marginal product
divided by the prices

00:08:58.870 --> 00:09:01.940
of the various factors
are equal to each other.

00:09:01.940 --> 00:09:04.640
So, for example, if I were to tell you

00:09:04.640 --> 00:09:06.560
that we are at a different
point of production,

00:09:06.560 --> 00:09:09.850
let me cordon this off,

00:09:09.850 --> 00:09:11.350
so if we're at a different
level of production,

00:09:11.350 --> 00:09:14.130
where our marginal product of labor

00:09:14.130 --> 00:09:16.930
is equal to, I'll call it 10 widgets,

00:09:16.930 --> 00:09:18.120
this saves time,

00:09:18.120 --> 00:09:21.813
and let's say that the price
of labor is equal to $5,

00:09:22.720 --> 00:09:27.180
and let's say that the price
of capital is equal to $10,

00:09:27.180 --> 00:09:31.220
what would have to be the
marginal product of capital

00:09:31.220 --> 00:09:35.760
for me to be indifferent
between labor and capital?

00:09:35.760 --> 00:09:38.770
Pause this video and
try to figure that out.

00:09:38.770 --> 00:09:40.930
Well, in order for me to be
indifferent right over here,

00:09:40.930 --> 00:09:43.330
that means that my
marginal product of labor

00:09:43.330 --> 00:09:45.020
divided by price of labor

00:09:45.020 --> 00:09:47.910
needs to be equal to my
marginal product of capital

00:09:47.910 --> 00:09:50.080
divided by my price of capital.

00:09:50.080 --> 00:09:54.390
And so, I would have 10 over five

00:09:54.390 --> 00:09:55.870
would have to be equal to my

00:09:55.870 --> 00:09:58.980
marginal product of capital over 10.

00:09:58.980 --> 00:10:03.150
So, 10 over five, this is
two widgets per dollar.

00:10:03.150 --> 00:10:05.870
And so, if I want two
widgets per dollar over here,

00:10:05.870 --> 00:10:08.733
this has got to be equal to 20.

00:10:09.900 --> 00:10:14.280
So, at this point, I'm
indifferent between producing,

00:10:14.280 --> 00:10:17.110
between bringing on more
capital versus labor,

00:10:17.110 --> 00:10:19.160
because in either case,
every dollar I bring on,

00:10:19.160 --> 00:10:21.290
if the marginal product of capital is 20,

00:10:21.290 --> 00:10:25.320
then I'm able to get
two widgets per dollar

00:10:25.320 --> 00:10:27.923
of investing in either factor.