I have long maintained that Economics is the fun science (for example, 8-29-2011, 8-30-2011, 11-4-2011, 3-21-2012, 3-21-2013). And I thought we needed a little fun on a Monday. We'll be reviewing how Beanie Babies fit in to the economic picture.
This was part of the lecture for last Monday’s Hillsdale College Economics 101 online course. The title for lecture 5 is “The Role of Profit.” [These courses are free, but you may need to sign up for a course to get access.]
Before we get to the economics of Beanie Babies, we need to cover a few preliminary concepts.
· Profit is revenue minus costs.
· Economic profit includes opportunity costs when subtracting costs from profit.Our teacher, Gary Wolfram, describes economic profits this way:
We want to include all the opportunity costs of all the resources that are being used up. Now, generally the opportunity cost of a resource is its price, but for some things it might not be included. So, for example, suppose you’re running a t-shirt shop in Hillsdale, and at the end of the year your accountant says, wow, you made $20,000. You might think that you earned economic profits of $20,000, but an economist would say, “Wait a minute. You might’ve earned $30,000 being the manager of the local Burger King.” So you have to include your opportunity cost of $30,000 when looking at total cost. So, to an economist your economic profit would actually be negative because, although you earned $20,000 in your revenue minus your cost in your t-shirt business, you could have made $30,000 being the manager at the Burger King.
So we often hear that firms make zero economic profit in a competitive market, at least whenever we take a Principles of Economics class, and you might say, well, gee, why is it that the firms are still making things if they’re making no profit? It’s because when we say they’re making zero economic profit, it means that they’re making exactly what those resources could have made in their next best alternative. You couldn’t have been doing better somewhere else. And so, economic profit just includes in the total cost all the cost including the opportunity cost of the people that are running the firm and all the labor and other inputs that are being used up.
Professor Wolfram explains that economic profit affects attraction to the market. When economic profits are positive, more firms are willing to enter that industry in hopes of making good use of their resources. He uses the e-reader market as an example. First there was an innovator. Then others see high prices and growing demand, so they enter the industry. Soon you have Kindle, iPad, Nook, and others, providing choice as well as lower prices for consumers.
What’ll eventually happen is the price will fall and more will be produced. So, economic profit attracts new firms into that industry. Shifting the supply curve to the right, driving prices down, increasing the quantity, and we generally observe that. If we observe a firm that’s making economic profit because it introduced a new product, the price is generally high, not too many are sold, other firms enter, compete against them, driving that supply curve out, driving down prices, increasing quantity.
The opposite can also happen. Once demand is low enough that economic profits become negative, firms leave the industry. This is where the Beanie Babies example comes in, when there’s a loss of consumer demand at any price. Here’s the slightly technical part that makes sense with the chalkboard chart:
|Gary Wolfram teaching Hillsdale's Econ 101 class, lecture 5|
If firms are making economic losses, they’ll exit the industry. As they exit the industry, because an economic loss says they’re making less with those resources than they could be making somewhere else. As those firms exit, we get a shift in the supply curve now to the left: price will rise to P2, and quantity will fall to Q2.
He makes several other good points in this half hour lecture. Here are some samples (some are paraphrased rather than exact quotes):
· Now, there are a number of things to observe about economic profit. First is that economic profit is a celebration. Firms must be doing what? They must be producing something of greater value than what the opportunity costs of those resources were.
· So, the net of this is that we don’t have a minister of culture, or we don’t have a production czar that says, “Producers, you need to do something because consumers’ demand has changed, increasing or decreasing.” The price system and the attraction of profits moves the resources from those industries where consumer demand is declining to those industries where consumer demand is increasing. That’s why markets are so dynamic. That’s why it instantly responds to changes in what your preferences might be.
· Economic profit is a celebration. Firms must be producing something of greater value than what the opportunity costs of those resources were. Rather than thinking of profit as a sign of exploitation, we should think of profit as a celebration, as saying that this firm made more with those resources than any other way of using those resources.
· Monopoly is only a problem when it’s something you are forced to buy (very few things—electricity, phone, for example) and there’s a barrier to entry into the industry. Usually a barrier to entry is caused by government regulation, or government choosing how many (often one) entities may be in the market. “Normally when we look at a barrier to entry, it’s because government created that barrier to entry.”
· Innovation is someone is thinking about what we are going to want three years from now—when we don’t even know yet that we’re going to want that—but when the time comes and we want it, the product will be there. Not good enough to do unto others what you want others to do unto you. You have to do unto others what they have no idea yet they will want done for them.
· Innovation requires risk; profit is incentive to take the risk.
So, what happened with Beanie Babies? Demand at any price decreased, such that it was no longer a profitable industry, and the product stopped being made. In some cases, such as vinyl records, demand increases to a point that the product gets made. But in some cases, demand never resurfaces (8-track tape players, for example), and we don’t get the product anymore.
This is an ongoing problem for me, because I tend to like specific products and lack enough fellow consumers to keep companies making them. Mr. Spherical Model requests that I stop insisting that this is the entire consumer industry pinpointing what I like so they can purposely stop production of those things just to spite me.
But I do not feel that way about Beanie Babies. We had a few, back in the day. Mostly the tiny ones given away with kids’ meals, plus a few received as gifts. I didn’t understand how a toy could be valuable only if you left the tag on it and didn’t play with it. Eventually the rest of the world caught on.
Now that you understand the economic profit concepts behind Beanie Baby, you’re ready to more fully enjoy this “real life” Beanie Baby scene. Studio C started as a college campus improv group that developed into a TV comedy sketch show—in its third season on BYUtv (available on various television services) and also online, a sketch at a time. Enjoy.