- [Instructor] Let's continue thinking
about how rational agents make decisions.
So here we're told that
Sally runs a business
that only sells hamburgers
in a building she owns.
Every month, they sell 5,000 hamburgers
at $5 per hamburger.
She spends $2 per hamburger
on supplies, bread, meat,
lettuce, et cetera.
She also pays Mike and
Raj each $2,500 per month
to work at the restaurant.
Finally, utilities cost $500 per month.
Sally works full-time at the restaurant
and keeps the accounting
profits for herself.
What is the accounting
profit of the business?
So pause this video and see
if you can figure that out.
All right now let's think
about this together.
We're gonna think about
it in terms of some
of the types of costs we've
thought about in the past.
So when we think about benefits,
and here we could think
about it to a firm, although
it's fully owned by Sally,
the benefit to a firm of
doing business is its revenue.
So the total revenue that she collects,
and everything we're gonna be doing
is going to be per month,
so her total revenue is going
to be her price times quantity
so it's going to be 5,000
hamburgers at $5 per hamburger.
So that is going to be $25,000.
Once again, all of this
is going to be per month.
So once again, we can view
this as the total benefit
that the firm, that her
business, is getting.
And now let's think about the costs.
So first we could think about
the cost of her supplies.
It's oftentimes referred
to costs of goods sold,
but I'll just write supplies here.
So costs, costs colon, so
let's put supplies, supplies.
That would be 5,000 hamburgers
times $2 per hamburger,
so that's a $10,000 cost, $10,000.
Then she has the cost of her employees.
So employees, I'll just write it,
I'll abbreviate it like that.
What's that going to be?
Well she has two folks
at $2,500 per month each.
So that's going to be $5,000,
two times $2,500, $5,000.
And then last but not least,
she has her utilities.
So utilities, let's do util for short.
That's going to be $500 per month.
And so from this we can
calculate the accounting profit.
So we get the accounting
profit, accounting profit,
is going to be 25,000 minus 15,500.
That's going to be $9,500 per month.
And she gets to keep all of this,
and so this seems like a
pretty good amount of money
to be earning.
She's earning six figures a year.
But the question is, is it
rational for her to do this?
Well some of you might
be correctly thinking,
well in order to determine
whether it's rational
for her to continue running this business,
we have to know what
the implicit costs are.
Here we've only just looked
at the explicit costs,
and the most important
of the implicit costs
is the opportunity cost.
And to factor that, we have to know,
well maybe what she could've
rented her building out,
if she wasn't running
this burger business,
and maybe what she could do with her time
if she wasn't working at
the business full-time.
So we need a little bit more
information and let's see
if we can get that.
So now we are told that Sally
could rent out her building
for $5,000 per month.
She can also make $6,000
per month as an accountant.
Based on this, what is the
economic profit of her business?
So pause this video and see
if you can figure this out.
Well one way to think about it is,
we can start with our accounting profit
and then subtract out
all the implicit costs,
especially these opportunity
costs right over here.
So her opportunity
cost, opportunity costs,
are going to be per month,
well if she doesn't run this business,
she could rent out her
building for $5,000 per month
and then if she wasn't
doing this full-time,
she could make $6,000 per
month as an accountant,
$6,000 right over there.
And so her opportunity costs
are a total of $11,000.
And so now her economic profit would be
her total benefit minus her explicit costs
minus her implicit costs.
Her economic profit, economic profit,
is going to be, well we
could start at the 9,500
and subtract the 11,000,
it is negative $1,500.
It's important to realize,
because economic profit
always factors in the explicit costs
and then other potential implicit costs,
economic profit will never be higher
than accounting profit.
And assuming there are
some implicit costs,
it'll always be lower
than accounting profit.
So now based on all of
what we've explored,
is it rational for Sally
to continue running
her burger business?
Well based on the
information we've been given,
it doesn't seem rational
for her to continue
running her burger business.
She makes $9,500 in accounting profit
from the business, but
she's incurring $11,000
of opportunity cost to do so.
And that's what makes her
economic profit negative.
This is not rational.
Now if we had more information,
maybe she hates being an accountant.
Maybe there's a benefit for her working
at the burger business.
She has more flexibility with her time,
she likes being self-employed,
she doesn't have
to listen to her manager
tell her want to do.
If that were the case,
then it would change
the calculations some
because there would be
an extra benefit from her
running her burger joint.
But we don't know, and based
on the information we have,
it doesn't seem rational
for her to continue.
