[music] Okay. It gets a little more complicated than

that. And let me explain that with a question.

Suppose that you in fact have own a barbeque sandwich.

Right? Like the one we've been talking about last

week and this week. And at the current level of production,

and the number of sandwiches you are actually producing, you have an economic

profits of equal to zero. All right, so your economic profits at

that point is zero. Now given that.

Let's say you have four choices. You should do what?

You should continue to operate? Should you get out of the barbecue

sandwich business all together? Should you expand your operation?

Or should you reduce your operation, alright?

So see if you can answer that question. Whether the answer, you can answer

correctly is going to tell you whether you understand the idea of profits that we're

introducing here. Well,as it turns out a lot of people at

the beginning will assume that if your economic profits are zero, you should get

out or you should reduce your operation. But as it turns out, if your economic

profits are zero, you're actually doing pretty well.

And economic theory will, will tell you, that you should continue to do whatever

you're doing and you're actually, you're doing it well and you should continue to

do it. Now to understand that you have to

understand the differences between what we call economic profits and accounting

profits, and in order to put it into the context of the example that we've been

using which is the one of the barbecue sandwich store.

Let's hear from Mike about what he says how hard it was for him to decide to go

into the business when he actually had a job to decide to start his own business.

So let's hear what, what he has to say about that and then let's put that into

context in the definition of accounting and merchant economic profits.

>> The story is that I was a bartender in Champaign at the Esquire Lounge.

I bartended there for 15 years. There were three owners of the Esquire and

well, late one night I was talking to one of them, Pedro Heller who ended up being

my partner in this business. He's, just telling him my idea and it was

just a conversation. We were just talking about things at

different locations and things that we liked.

And ideas of restaurants, and he liked what my idea was.

So we spent about a year, looking for a place, to open up.

And he kind of taught me a few things along the way.

He was just sort of introducing me to the idea and the process of how we do things.

We found this place. I happened to know the guy that owned the

place, and I knew that he was looking to get out.

I had heard it on the street and I'd kind of heard it from him and talked to him.

So when we bought the, we bought the building and then I quit my job at the

Esquire once we bought the building. And actually I quit my job when my twin

sons were born which was about a month before we bought the building.

So I was unemployed and opening up this business.

I had no income in all until this business opened and for a while after to be honest.

The most expensive thing about it was just my living day-to-day.

That was tough, but my wife works and we got through it.

But she wasn't working that much because of the twin sons.

Right now, yes, it seems like it was a no-brainer.

It seems like it was the thing to do. It wasn't that obvious in the first few

months. But, but, yeah, it quickly, p, it quickly

caught on. And, and things eh, you could see the

light at the end of the tunnel. But, you know, the day-to-day things in

the beginning it was, you know, it was a little tough.

>> So what did Mike say? It was really, really hard for him to

start a business. You have to make a lot of sacrifices.

And perhaps the biggest sacrifice that he made was that in order to put any time for

his business, he had to quit his job. So for Mike if, if his barbeque sandwich

business was going to be any success, he had to at least give as much money at some

point, you have to give as much money as he was making when he was a bartender.

So what economic, profits do is to take that into consideration at the time of

considering whether that person should make any business decision.

Let me give you some numbers to put that into, into some kind of, hypothetical

context. Say that the ah,the salary that Mike could

make bartending was actually, a hundred dollars per day, all right.

And say that for simplicity, let's say the revenue that he gets from the sandwiches

or whatever he's doing in his new business, is about $200 per day.

And say that the operating cost per day, right.

And I don't know, this is probably more. These numbers are, are hypothetical, but,

you know, the magnitude of the numbers is not critical.

It's about $100 per day. The question is what are Mike's profits,

what are Mike's, profits here. Well, it depends on who's calculating

this. If, if an accountant was, was calculating

this. The accounting profits that an accountant

will calculate, will be equal to the, the revenue that Mike's made, the $200, minus

the operating costs of 100, and you have a profit of 100.

But this doesn't include opportunity costs, because we know that the

opportunity costs, as Mike, we learned from Mike, of actually him having his, his

own business, is the salary that he's not drawing from bartending.

And that salary, that opportunity cost is equal to $100 per day.

So an economist will take into consideration those costs.

So when an economist calculate profits, he actually not only considers the accounting

costs, which are this $200 here. The operating cost, but also the

opportunity cost. So, economic profits, which are the

profits we will talk about this week and ever in this class, are going to be the

$200 in revenue he makes minus the operating cost minus the opportunity cost,

and that is equal to 0 in the case of Mike.

So you see that, in that, economic profits are zero, it's already taking to

consideration the money he's making, right.

Because if he makes zero economic profits, that means that he's paying himself a

salary that is as high as he will pay himself or he will get paid if he were

working somewhere else. So when we talk about economic profits, we

include the opportunity costs. And that's very, very important.

Because that will mean, and later on we'll see, that economic profit is zero.

Meaning that you are paying yourself a salary that is as high as you will be,

making when you're doing anything else instead of what you're doing.

Okay. So remember that every time we say

profits, what we mean is economic profits that includes opportunity costs.

And later on when we do our final equations it's going to be very, very

important that you understand that distinction.

[music] Produced by OCE Atlas Digital Media at the University of Illinois

Urbana-Champaign.

2.2. The Profit Equation

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