What is Costs, Revenue, and Profit? | Introduction | IB Microeconomics | IB Economics Exam Review

Summary

This introductory video delves into the foundational concepts of production costs, revenues, and profits within the theory of the firm. It distinguishes between the short run, where at least one production factor is fixed, and the long run, where all factors are variable. The video underscores the significance of understanding the law of diminishing returns and its impact on production efficiency. It also elucidates on total, marginal, and average product and revenue, highlighting their interplay. The speaker demystifies economic profit by incorporating opportunity costs, emphasizing that a firm is economically profitable only when it covers both explicit and implicit costs, thus setting the stage for analyzing market structures.

Takeaways

• 📚 This video serves as an introduction to the concepts of production costs, revenues, and profits within the theory of the firm.
• 🔍 It aims to provide a foundational understanding of these economic terms and how they interrelate.
• 🏭 The video discusses the short run and long run in production, emphasizing the fixed nature of certain factors like land or capital in the short run, and the flexibility in the long run.
• 📉 The law of diminishing returns is introduced, explaining how productivity decreases as more labor is added to a fixed input.
• 📈 The script differentiates between total, marginal, and average product, relating these concepts to total, marginal, and average costs and revenues.
• 💼 Revenue is defined as the money a firm makes from selling goods or services over a given period, with total, marginal, and average revenue being key components.
• 💰 Economic profit is distinguished from accounting profit by including opportunity costs, such as what the entrepreneur could have earned doing something else.
• 🏢 The video uses the example of a maté factory to illustrate the concepts of fixed and variable inputs, and the implications for production and costs.
• 📉 The law of diminishing marginal returns is highlighted as a critical concept for understanding market structures like perfect competition, monopoly, monopolistic competition, and oligopoly.
• 💡 The video stresses the importance of understanding economic concepts not just in theory, but in the context of real-world business decisions and market behavior.
• 🌟 The overview provided is meant to set the stage for applying these concepts to analyze different market structures in more depth.

Q & A

What are the main topics covered in the introductory video?

The video covers production costs, revenues, and profits in the context of the theory of the firm. It introduces concepts like the short run, long run, law of diminishing returns, and the difference between total, marginal, and average in the context of product, cost, and revenue.

What is the difference between the short run and the long run in production?

In the short run, at least one factor of production (like land or capital) is fixed and cannot be changed by the firm, while in the long run, all factors of production can be changed. Production takes place in the short run, and planning takes place in the long run.

What is the law of diminishing returns and how does it relate to production?

The law of diminishing returns states that as more units of a variable input (like labor) are added to fixed inputs (like land or capital), the marginal product of the variable input will eventually decrease. This means that adding more workers to a fixed production environment will initially increase output, but at some point, each additional worker will contribute less to the total output.

How is the total product calculated?

The total product is calculated by adding up all the units produced. It represents the total quantity of output from a production process.

What is the relationship between marginal and average product?

The marginal product is the additional output resulting from adding one more unit of labor. The average product is the total output divided by the number of units of labor. The marginal product can affect the average product; for example, if the marginal product (the output of the next worker) is high, it can increase the average product, and if it's low, it can decrease the average product.

How is total revenue calculated?

Total revenue is calculated by multiplying the price of a good by the quantity of goods sold. It represents the total amount of money received by a firm for selling its products over a given period.

What is the difference between marginal revenue and average revenue?

Marginal revenue is the additional revenue generated from selling one more unit of output. Average revenue is the total revenue divided by the number of units sold, representing the revenue per unit sold.

What is economic profit and how is it different from normal profit?

Economic profit is the firm's total revenue minus total economic costs, which include both explicit costs (out-of-pocket expenses) and implicit costs (opportunity costs). If the economic profit is positive, the firm is said to be earning abnormal profit. If it's zero, the firm is earning normal profit. If it's negative, the firm is incurring a loss.

Why is the concept of opportunity cost important in calculating economic profit?

The concept of opportunity cost is important because it includes the potential earnings that could have been made if the resources used in the business were employed elsewhere. This ensures that the calculation of economic profit reflects the true profitability of the firm, considering all costs, including what could have been earned by not engaging in the current business activity.

How does understanding the concepts in this video help in analyzing market structures?

Understanding the concepts of production costs, revenues, and profits helps in analyzing market structures because these are the fundamental drivers of a firm's behavior in different market conditions. They form the basis for understanding how firms maximize profits, respond to competition, and adjust to market changes in various types of market structures like perfect competition, monopoly, monopolistic competition, and oligopoly.

Outlines

00:00

📚 Introduction to Production Costs, Revenues, and Profits

This paragraph introduces the viewer to the concepts of production costs, revenues, and profits within the theory of the firm. The video's goal is to provide an overall understanding of these economic terms and how they relate to market structures such as perfect competition, monopoly, monopolistic competition, and oligopoly. The instructor emphasizes the importance of distinguishing between the short run and the long run in production, where the short run is the present and the long run is the future. The short run is defined as a time period during which at least one factor of production, such as land or capital, is fixed. The long run is when all factors can be changed. The paragraph also introduces the law of diminishing returns, which is divided into the law of diminishing marginal returns and the law of diminishing average returns, and their relevance to understanding market structures.

05:01

📈 The Law of Diminishing Returns and Production Planning

This section delves into the law of diminishing marginal returns and its counterpart, the law of diminishing average returns. It explains how adding more labor to a fixed input, like a classroom in the example, initially increases production but eventually leads to a decrease in productivity due to overcrowding. The paragraph illustrates the concept using a classroom scenario where adding more students (labor) to produce 'mate' cups leads to increased output initially but then starts to decrease as the classroom gets too crowded. The instructor emphasizes the importance of understanding these laws for grasping how markets function.

10:01

💼 Understanding Total, Marginal, and Average in Production and Revenue

The paragraph discusses the concepts of total, marginal, and average in the context of production and revenue. It explains how total product is calculated by adding up all the units produced, average product is found by dividing the total product by the number of units of labor, and marginal product is the additional output from adding one more unit of labor. The instructor draws parallels between these concepts in production and their equivalents in revenue, namely total revenue, marginal revenue, and average revenue. The explanation is designed to simplify the economic jargon and make it more relatable, using examples such as selling M&Ms to illustrate total revenue.

15:03

💹 Economic Profit and Opportunity Costs

This paragraph focuses on the economic concept of profit, particularly economic profit, which includes both explicit costs (out-of-pocket expenses) and implicit costs (opportunity costs). The instructor uses the example of an entrepreneur who放弃了 a high-paying job to start a 'mate' factory, highlighting the opportunity cost of her decision. Economic profit is defined as total revenue minus total economic costs. The paragraph clarifies that a firm is only considered profitable in an economic sense if it covers all its implicit and explicit costs. The instructor also explains the difference between supernormal profit, normal profit, and loss, depending on whether economic profit is positive, zero, or negative.

Keywords

💡Production Costs

Production costs refer to the expenses incurred by a firm in the process of producing goods or services. In the video, the instructor discusses how these costs are analyzed in both the short run and the long run, emphasizing the importance of understanding the fixed and variable costs. An example given is that in the short run, land or capital might be fixed, while labor is variable and can be adjusted to cut costs quickly.

💡Revenues

Revenues are the income generated from the sale of goods or services. The video script explains revenues in terms of total, marginal, and average revenue. Total revenue is calculated as price times quantity sold, while marginal revenue is the additional revenue from selling one more unit, and average revenue is total revenue divided by the number of units sold.

💡Profits

Profits are the financial gain derived from business activities after all costs have been deducted from revenues. The video script defines economic profit, which includes not only explicit costs but also implicit costs such as opportunity costs. An example used is the entrepreneur who gives up a job as a doctor to start a factory, where the foregone income represents an implicit cost.

💡Short Run

The short run is a period during which at least one input factor in production, such as land or capital, is fixed and cannot be changed. The video uses the analogy of a classroom being used as a factory to illustrate how in the short run, adding more labor (students) can increase production (making mate cups), but there comes a point where adding more labor leads to diminishing returns.

💡Long Run

The long run is a period during which all factors of production can be changed. It is the time frame in which planning takes place, as opposed to the short run where production occurs. The video script mentions that in the long run, if demand for mate cups increases significantly, the entrepreneur might plan to build another factory to increase production capacity.

💡Law of Diminishing Returns

The law of diminishing returns states that as more units of a variable input (like labor) are added to a fixed input (like a classroom), the marginal product will eventually decrease. In the video, this concept is used to explain why adding more workers to a fixed space can initially increase production but will lead to overcrowding and decreased productivity.

💡Total Product

Total product refers to the total quantity of output produced by a firm. In the video, the instructor explains that total product is simply the sum of all the goods or services produced, using the example of making mate cups in a classroom factory.

💡Marginal Product

Marginal product is the additional output produced by adding one more unit of labor. The video script uses the example of adding an eleventh worker to a team of ten workers to illustrate how the marginal product is the output produced by that one additional worker.

💡Average Product

Average product is calculated by dividing the total product by the number of units of labor. The video provides the analogy of calculating the average height of students in a classroom to explain how average product measures the productivity per worker.

💡Explicit Costs

Explicit costs are the out-of-pocket costs that a firm pays for inputs like rent, materials, and wages. The video script differentiates these from implicit costs, emphasizing that economic profit only occurs when a firm covers both explicit costs (like paying for land or labor) and implicit costs.

💡Implicit Costs

Implicit costs are the opportunity costs of the resources used in production, such as the potential income an entrepreneur could have earned by not starting the business. The video uses the example of an entrepreneur who could have earned a salary as a doctor but chose to start a factory, where the foregone salary is an implicit cost.

Highlights

Introduction to production costs, revenues, and profits in the theory of the firm.

Explaining the concept of costs, revenues, and profits in the context of the firm.

Differentiating between the short run and the long run in production.

The short run is defined as a time period with at least one fixed factor of production.

The long run is a period where all factors of production can be changed.

The law of diminishing returns and its impact on production.

The law of diminishing marginal returns and its relationship with average returns.

The concept of variable and fixed inputs in the context of production.

Labor as the variable factor of production that can be quickly adjusted.

The example of a classroom as a factory to illustrate fixed and variable inputs.

The total product, marginal product, and average product in production.

The relationship between marginal and average in production and cost.

Revenue defined as the money firms make from selling goods and services.

Total revenue, marginal revenue, and average revenue explained.

Economic profit includes both explicit costs and opportunity costs.

The importance of covering opportunity costs for a firm to make economic profit.

The difference between abnormal profit, normal profit, and loss.

The application of cost, revenue, and profit concepts to market structures.

Transcripts

hey hey everybody I hope you're doing

well today well this is the introductory

video to production costs revenues and

profits for theory of the firm the

design of this video is to give you an

overall picture of exactly what you're

gonna study in this unit

what are costs what our revenues what

our profits how are we going to look at

it

what does production mean and how are we

going to figure all this stuff out

because basically what we're doing right

now is we're beginning to build a very

dynamic diagram that we are going to use

to apply towards the market structures

of perfect competition monopoly

monopolistic competition I'd like that

and oligopoly okay here we go all right

some key core critical concepts cost and

production is one section of this unit

revenues is another section of this unit

and profit is another section of this

unit but one of the big things that

overarching idea about the short-run or

about this unit are something called the

long the short run the long run and the

law of diminishing returns which is

divided into two different sorts of laws

one is the law of diminishing marginal

returns and the other is the law of

diminishing average returns and as well

see they're very much related to one

another okay so the idea here is that

after this video you understand what

cost and production means you understand

the basic elements of revenue and the

basic elements of profit all right here

we go

all right cost and production or

sometimes and some course companions

just talked about as cost all right

super important thing you need to get

here and the best way to do it is to

understand the difference between the

short run and the long run one thing I

say to my students here it's not the

I'll go too late is the short runs the

present tense all right just remember

that the long run yeah that's the future

so if you think about the future as

being the long run and the short run

being right now then skip the

definitions you'll realize that you

can't produce anything in the future you

are only producing things in the present

tense and therefore a distinctive

difference between the short run in the

long run or the press

and the future is that production takes

place now in the short run in the future

ah that's where all the planning takes

place right or that's where the planning

is that's what you're thinking of when

you're doing the planning so the long

run is where the planning takes place so

let's take a look at the definitions to

make a make it a little bit clearer okay

the short run the short run is a time

period during which at least one factor

production is fixed such as land or

capital and cannot be changed by the

firm okay so one element the factors of

production you remember the factors of

production are land labor capital and

entrepreneurship forget entrepreneurship

for a second land labor capital okay it

says that one of them is fixed either

land or capital well that makes sense

because other than the least valuable to

take the most effort to change in fact

they take the most time to change and

therefore you'd have to plan that what

takes the least amount to change labor

and if you look at any firm the first

thing it's gonna do is when things are

bad is fire workers why because it's

easiest to do right if you work at a

school and the school all of a sudden

isn't doing well financially are they

gonna start knocking down buildings now

that would be destroying their capital

or just throwing their land no they're

gonna start firing workers teachers and

maintenance people whatever right so

that's the case that's the variable

factor is always labor in in theory of

the firm and keep that in mind variable

variable variable labor labor labor

people losing their it's the easiest

thing to get rid of it's also the most

expensive thing to maintain therefore

you can cut your cost the fastest by

firing labor okay so in the short-run

land or capitals fixed and labor is

changeable okay and all production takes

place in the short run the long run is a

time period in which all factors of

production inputs can be changed right

and one really easy thinking really

thing easy way of putting this is like I

don't know if you know what math day is

if you don't live in the southern

hemisphere and it's Apogee and it might

not know what math day is but math is a

kind of T and it comes from the southern

cone of South America and Chile nose and

Argentinians and special Uruguayan's

drink tea this type of tea a lot okay

what's it served in a little cup if you

can picture a coffee cup you can kind of

picture mount a cup so I I like to think

about my classroom is a production of

Mothe

cuz I love the drink mob they you drink

it with a little straw you put the tea

in there you pour the water in it you

drink it through this this straw that

has a filter on it and if we're gonna

you know the example for my class is

like okay let's let's create my pay

okay cool we're gonna make these little

muffin cups all right well production

how do we gonna do that well we give my

classroom for the factory right and Mott

they were the product right and the

students were the labor okay what's the

most fixed thing well if my classroom is

the factory then that represents a fixed

asset right a building right and the

loan that I might take out to start the

business would also be fixed

okay so what's changeable well the labor

is changeable and I could add more

people right in the short-run to make my

pickups in a production at first would

go up right but then at some point in

the classroom you get too crowded and

we'll talk about that in a second right

but in the long run let's say mate' cops

were selling like crazy and all of a

sudden I wanted to increase demand what

would i I would want to increase supply

cuz demand is so high I've sold off all

my MOT that comes what what I did why

would need to build another building so

I would need to sit in the back of the

room and like do all the planning to

create a different factory right to

create more math day then I could hire

my workers I'd get another loan probably

do that but as soon as that other

factory that other room that other

factory is up and running boom back into

the short-run okay so the short run in

the long run are really important in the

short run at least one factor production

is fixed in the long run they're all

changeable all production takes place in

the short run and all planning takes

place in the long run okay

second huge point of cost and production

the law of diminishing marginal returns

hmm and analogous to this is the law of

diminishing average returns so what does

this mean what it means is that in the

short run okay as you add before I read

this as you add more labor to my mata

factory in my room right from the 10th

to the 11th to the 12th and 13th 14th

15th 16th 17th 18th 19th maybe the 20

20th person right that comes into my

room as a worker probably you can

imagine

we would be able to you know increase

our production right we would be able to

increase production as a result of

having one more unit of Labor and it

would go like that so our product

productivity would rise as we added more

people but then what would happen at

some point

and maybe it's the 21st worker the 22nd

23rd for me it would just get and I have

a beautiful classroom but it would just

get too crowded in there and our

productivity what would happen it would

steadily start to diminish

okay well that diminishing right

productivity is also like saying like

diminishing Prada diminishing

productivity is also another way of

saying you're diminishing efficiency

okay so the law of diminishing returns

says that as more and more units of a

variable input such as labor are added

to fixed inputs such as land or

capitalist more workers come into my

classroom the marginal product of the

variable input the marginal output of

each worker would rise but there comes a

point when the marginal product which is

the additional of one more unit of labor

would be continued would begin to

decrease and continue to do so another

way of saying that is extra units of

variable factor added to a given

quantity of fixed factor as more workers

are added to the classroom to make monta

the output from each additional unit of

variable factor each labor will

eventually diminish okay that is the law

of diminishing returns and if you're

talking about the marginal return it's

more than an average return would also

do that all right

super big point make sure you understand

that that's the backdrop of

understanding how these markets function

all right now costs total product

marginal product average product now

what you're going to see in cost is that

you're gonna see a repetition of total a

repetition of the use of the word of

total or use that doesn't work let's go

read the repetition of total of marginal

and of

and then if you think of those as this

the prefixes of a single word what

you'll see then is the sub the suffix is

of product product and product are going

to change to costs and revenue but the

way you the way you figure out the total

of anything just think about it don't

get all caught up in all this

you know jargon you just add the stuff

up man

what's product that's the total amount

that you that you produce so the total

product is all the stuff that you make

or the quantity that you make come on

you can figure that out

what about average skipped marginal what

about average what's average the total

quantity of average per out per unit of

labor hmm the variable input what does

that mean well the average product the

product is output and the variable is

labor then the average would be like

well how much do we make per what worker

right and it's just like you know look

if you have a I don't know if you added

up the height of all the kids in an

elementary school classroom and they all

ended up being like you know 4 feet tall

you know a meter point to five or

something and then what the next kid

that walks in is like super tall what's

gonna happen to the average it's gonna

go up oh cool how would you figure out

that average well you would add up all

their Heights and then divide by the

number of people in the room so what's

average the average of anything is just

the total divided by the amount of them

so what's the total quantity divided by

what the labor that's average product or

average output marginal what's that well

this is the extra additional output

resulting from the additional unit of

one labor this tells us how much output

increases when one unit of labor is

added so marginal if we have you know we

have ten workers and we add an eleventh

worker the marginal product is the

amount of work amount of output that

that one eleventh worker does it's the

margin okay and you're gonna see that

these two aspects the margin the

marginal of anything and the average of

anything are intimately related and that

makes sense just like if the marginal

like student to walk into the next

student walks into the room at

elementary school and is really tall

then the marginal height right is going

up and what's gonna happen to the

average it's going to go up if the next

person that walks into the room is

shorter what's gonna happen to the

average is gonna pull the average down

right because the average person the

last person that came in is short for us

can pull the average down so marginal

and average are always related to one

another it doesn't matter if you're

talking about product or if we're

talking about cost if we're talking

about revenue okay that's a really

important point don't forget that or you

can get really confused in all of this

language all right next slide revenue

what's revenue if the money that firms

make there okay yeah that's the payments

oh you wanna you want IB jargon the

payments firms receive when they sell

the goods and services they produce over

a given period of time yeah it's the

money they make in a year okay hey check

it check it check it one two what do we

have here oh my gosh we got total now

we're not going yellow we got to go red

we got total we got marginal and average

again oh wow how what is it now well the

suffix this time is revenue revenue

revenue oh well how do we figure out

total revenue Oh will we add it all up

and then we divide we multiply by what

by the price if we have a hundred things

and we're getting ten bucks of things

the average the total revenue is a

thousand dollars it's not hard right

what's the marginal revenue uh well

let's see

if you add one more thing how much more

revenue do you have oh that's your

marginal revenue all right what's the

average revenue oh that's like all of

the things that's the right we have

revenue divided by what well the things

we sold so if we have a thousand dollars

and we sold you know a hundred things

guess what the average revenue it's ten

bucks come on there's a logic you can do

this you don't have to be like some

economist to figure this out but when

you put it in terms of like all these

terms sometimes I could just get crazy

in your head and you think you don't

know what you're talking about and you

actually do but let's get some real

definitions for those all right total

revenue marginal revenue average revenue

pretty straightforward

total revenue TR you need to know that

is the total amount of money received by

firms when they sell a good a product is

equal to the price of a good times the

quantity of the goods sold that's

obvious it's price times quantity

you've been calculating out total

revenue all throughout your studies if

you want to know how much money you make

when you sell M&Ms out of your backpack

in your classroom

how many backpacks how many M&Ms do you

ever down the beginning of the day fifty

you know how much did you sell him for

one dollar how much money you got fifty

bucks

total revenue marginal revenue the

additional revenue arising from the sale

of an additional unit of output we've

already talked about that and then

average revenue the average per unit the

average per unit of output sold

calculated by dividing the total revenue

by the number of units sold of course

all right so if you divide total revenue

by how much units you sold or how much

output there was you're gonna get the

average all right this is not hard but

when you are like a new econ student or

new did theory of the firm is we're

gonna be good

total revenue margin remember if you're

how am I gonna figure that out now just

stop a second thing this division folks

you know is 5th grade math you can do

this you understand what total marginal

average are as the prefix is and guess

what you understand that all you're

doing is the same math but for a

different suffix right in this case

revenue all right odd word last thing of

costs revenue and profits is of course

you guessed it profits all right one

important thing to realize here that you

need to know is what an economic cost is

because an economic cost includes not

just the explicit costs of what a firm

pays out they supposed to cost the

things that a firm would pay with cash

or money coming out of their pocket they

would have to pay for the rent for the

place I have to pay for the loan they'd

have to pay for the materials to make

the mouth a cup ceramic and whatnot and

it also have to pay the wage for the

laborers ok that's obvious right but

economic profit is a term that's it's

important because what you have to do is

you got to think about what what

economic profit takes into account is

the opportunity cost remember we I told

you to not worry about the entrepreneur

at land labor capital entrepreneur well

that last factor production is the

entrepreneur and let's say she was a

doctor at a local hospital and made a

hundred thousand dollars a year that

entrepreneur gave up a hundred thousand

dollars a year to come I don't know

start him out day factory making ma take

cuffs because she's a Jelena and she

loves my know okay so she's the

entrepreneur who started this factory

she gave up a hundred thousand dollars a

year that's an opportunity cost of her

doing this so that

isn't what's called an implicit cost

that the firm must cover in order to

actually be making what is known as

economic profit okay

so economic profit is different than

just straight-up profit because economic

profit takes into account the

opportunity cost for gone by the

entrepreneur okay there are other

opportunity costs right let's say in

this map a factory that this

entrepreneur has she's making what could

have made a hundred thousand dollars a

year but she built this factory this

building that could be rented out for

twenty thousand dollars a year hmm if

that can be if that could be rented out

by twenty thousand dollars a year then

that means that she could shut the

factory down earn twenty thousand

dollars a year by renting out the

factory to another firm to make

something and then go back to her job as

a doctor making a hundred thousand

dollars a year so the implicit cost of

starting up this mate' factory is a

hundred and twenty thousand dollars okay

this firm does not make economic profit

until it makes what it covers the costs

of that opportunity cost which in the

case of my example I made up is under

twenty thousand dollars so it would be

priced all of their land labor capital

plus the implicit costs okay so let's

take a look at this

the definition of economic profit is the

firm's total revenue minus total

economic costs if the firm if the profit

economic profit is positive then we say

it is super normal or more commonly said

abnormal profit if the profit is zero

then we say in IB economics and in

economics that the firm is earning

normal profit and if the profit is

negative we say the firm is earning a

loss or negative profit negative profit

is a economic term okay so it's really

important that you understand that a

firm is not quote profitable in an

economic sense and we are economists

until it covers all of its implicit and

explicit costs right explicit costs are

the things that pays out of its pocket

there's the obvious cost and the

implicit costs are the opportunity cost

for gone by the by anything that could

have been earned by doing something else

right okay

so there you have it my friends you have

an overview right of production costs

revenue and profit I hope you found this

video to be helpful you're launching

into your studies of theory of the firm

it's super cool you're gonna love this

unit it's gonna make all of these

decisions that make that happen all the

prices of goods you see in the store

kind of makes sense and you wonder why

do they pick that are they maximizing

profits are they satisficing and all

this other stuff that gets do we get

into a theory of the firm and this is

the first overview of the first video of

the overview of the first unit cost

revenue and profit which creates the

model that you're going to apply to

these market structures in the future

all right my friends take care of

yourselves be safe I hope you found this

video to be helpful and we'll talk to

you in a bit