Cost, revenue, and profit

0:00- [Instructor] What we're gonna do in this video is familiarize ourselves with ideas of cost, revenue, and profit. So let's start with cost, and we're primarily going to focus on the point of view of the supplier. You could think of someone who owns a business, and we're gonna think less from a consumer point of view because one person's cost could be another person's revenue, and I'll talk about that in a second.

0:24But generally, when you talk as a consumer of paying for something, you might say, oh, that cupcake cost me $4. You might also say the price of that cupcake is $4, and those are used interchangeably in everyday language. But in economics terms, when you talk about cost, it's usually what is the opportunity cost?

0:45What could you have done? What was your best option to do instead of that? But what we're gonna focus on in this video is primarily what's happening from the producer's point of view, from the supplier's point of view. And there the cost is what they need to pay in order to have the inputs to production, the land, labor, capital, et cetera, energy that they need to produce things.

1:11You could also think about that in terms of opportunity costs. They could have tried to use other resources instead. And so that could be another way of perceiving it. And then we're gonna think about revenue. Revenue is what a business brings in, so what people are paying it.

1:26But sometimes people get confused between revenue and profit. Revenue is just what comes into the business. Profit is what is left from revenue after paying for costs. So let's dig a little bit deeper with this example. Kataleya's Delightful Cupcake Shop used AI to create an image of a fancy cupcake shop.

1:45And I made it fancy because it looks like Kataleya is charging $4 per cupcake, so it better be fancy. But let's break down first the cost side of things. So first up, we have the fixed costs. These are costs that Kataleya's going to pay, regardless of how many dozen cupcakes her store is actually producing.

2:09And you can see whether it's zero dozen, 10 dozen, 11 dozen, 12, 13, 14, 15, always paying $400, and they're not giving us the time period that these fixed costs are, but let's say this is maybe per week for her rent and supplies and things like that. Or maybe this is just the amount that she has spent on all of this fancy equipment and the building, et cetera, divided by whatever period this is.

2:34But regardless however many cupcakes she produces in that period, you're going to have the same fixed costs. Next, we move on to variable costs. Now, these are costs that are driven by the number of cupcakes that she actually produces. And these are going to be costs like, these are like flour and sugar and icing.

3:00I guess that might be the sugar. But the things that every time you produce a cupcake, it incurs more cost. And you can see that the more cupcakes produced, the more variable cost. Now you have total cost. And total cost is just fixed cost plus variable cost is equal to total cost.

3:18And you can verify that, that 400 plus zero is 400, 400 plus 20 is 420, 400 plus 25 is 425, and so on and so forth. Now, what are we talking about when we say marginal cost? Well, that's the cost of producing that incremental next dozen. And so how do we calculate that?

3:40Well, look, when you go from 10 dozen to 11 dozen, now your total cost has increased by $5. So we can see our marginal cost is $5. When we increment by one more dozen, then our total cost has been incremented by $15. And we see that right over there. So this helps someone running the business say, "All right, every time I produce another dozen," and this is marginal cost per dozen, not per cupcake, "how much more is that going to cost me?"

4:14Well, now let's think about the money that's actually coming in, not the money that's going out of the business, because the whole point of producing these cupcakes is to sell them. And so here, actually, let's just go to revenue. I probably would've swapped these two if I had to do it over again, but this is fine.

4:31Let's go straight to revenue. So the revenue is the money coming in the door that customers are paying to buy these cupcakes. So you sell no cupcakes, you're going to get no revenue, no cupcakes to buy. But we can see here that if Kataleya is producing 10 dozen and sells those 10 dozen for $400 and you can see that's $40 per dozen, then she is bringing in $400 of revenue.

5:02But it's still not a great business at that level 'cause if you're bringing in $400 of revenue and you subtract out your total cost of 420, you're actually losing $20 at that point. So let's see what happens when we produce more. So if we produce 11 dozen, well, if we sell that 11th dozen, well, now we're bringing $440 in revenue, and our total cost is 425.

5:26We are finally making a profit. What is this marginal revenue telling us? It's how much are we making per extra dozen? And this to some degree is dictated by the business owner where they could say, "All right, I wanna charge $40 a dozen, so every time I sell a dozen, I'm gonna make 40 extra dollars."

5:44And if you think about it, and that's not always going to be the case, sometimes they might make a special deal where your second dozen is going to cost more or sorry, cost less to incent people to buy more, et cetera. So it's not always a fixed marginal revenue like this.

5:59But if you think about it, it's very rational: for someone to keep producing, as long as their marginal revenue is higher than their marginal cost, as long as that incremental dozen, they're going to be able to get more for it than what it costs them to make that incremental dozen, they should keep on doing that.

6:16Now, business is never that simple. Oftentimes you can produce a lot, but you might not be able to sell it all. And then maybe some of that variable cost went to waste and you're gonna have spoilage, et cetera, et cetera. So these are all things that you have to think about as a business owner.

6:30So when you think about profit, you're thinking about total revenue minus total cost. Let me write that down just because it's important. Profit equals total revenue, total revenue minus total cost, total cost, and then total cost can be broken down into fixed cost plus the variable cost, which is what we saw over here.

7:02Now, what would happen if the input costs of Kataleya's cupcakes increase? So that's probably going to be the variable cost right over here. Well, if these variable costs go up and Kataleya isn't able to get more revenue per cupcake, well, then her profit's going to go down.

7:20Likewise, if the costs decrease, either the fixed or the variable costs, well, then her profits will go up. If she raises prices and still is able to sell the same volume, her profits will go up if her costs stay roughly the same. So in a business like this, the motivation is for Kataleya to have the maximum profit over time without doing anything unethical, anything shady, anything unlawful.

7:47And over time, sometimes you might maximize profit in the short run, but it might hurt your profit in the long run. A good business owner's thinking about it over a long period of time, how do they maximize profit? And now you know the basic levers.