in my experience the profit maximizing rule is a difficult concept for people to fully grasp it seems very simple but it stands on a lot of complex ideas like implicit costs diminishing marginal returns and competitive markets but it is true if a firm wants to maximize their profits they must meet this condition they need to produce until marginal revenue is equal to marginal cost anything else is leaving money on the table that said whether or not it is worth producing anything at all depends on the time frame we are talking about economists distinguish between the short run and the long run in the short run some costs are fixed and cannot be changed in the near term an example is committing to a 12-month lease on a storefront no matter what you produce you are locked into making those rent payments and so this cost sets a short run of 12 months after the 12 months you could renegotiate or move or shut down but for the next 12 months your options are constrained by this agreement the time frames are less clear but similar logic applies to equipment rentals and purchases of equipment as well as any loans you take out to start or run your business these fixed costs limit your options for expanding your business or scaling it down until you reach a point where new decisions can be made the long run is a bit ambiguous but it's basically a length of time where those big fixed costs decisions can be altered in the long run all costs are variable and you can renegotiate leases upgrade or downgrade equipment and refinance or pay off loans in order to scale up or scale down your business to make new quantities profitable let's look at our bread baking business again I'm using the same numbers here that I used in the last video we're able to sell every loaf of bread we make for one dollar that makes total revenue very easy to compute if we sell zero loads we make zero dollars if we sell one we make one dollar if we sell seventy one we make seventy one dollars and so on now let's add some costs to the mix I'm going to assume we have fixed costs that work out to fifty dollars per day then we have the variable costs these come directly from all those slides that went whizzing by in the last video the marginal cost of the first loaf was 10 cents and so the total variable cost of producing one loaf is 10 cents the second one had a marginal cost of 10 cents too and so the variable cost for two loaves is 20 cents total and then 30 cents and 40 cents and so on eventually those marginal costs Rose adding 21 cents 22 23 and so on all the way up to adding a full dollar to the total variable cost when we produce that 75th unit these variable costs are the cumulative total of all the marginal costs the total costs then are just the fixed costs plus the variable costs from these numbers we can calculate marginal revenue and marginal cost each loaf of bread adds one dollar to our Revenue so the marginal revenue is constant at one dollar the marginal cost is the change in the total cost of production from one loaf to the next you can see how it changes as we go what's great about the profit maximizing rule is that if we look only at these numbers it's hard to tell which quantity is profit maximizing but it is indeed where marginal revenue equals marginal cost take a look at this profit column which we get by taking total revenue and subtracting total cost the largest number possible here for profit is at a quantity of 75. but look because our fixed costs were pretty high we are actually losing a dollar 25 each day should we stay in business or not I usually get two answers here either no we shouldn't or it's probably okay because it's just a dollar and 25 cents and it might be worth it to keep going if you're passionate about it but both of these answers are wrong losing a dollar and 25 cents is the best we can do in the short run if we were to shut down we would produce zero loads of bread earning zero dollars but still be paying the fifty dollars in fixed costs only in the long run when we can get out of those fixed costs too would we decide to go out of business and we definitely would go out of business remember this isn't accounting profit this is economic profit opportunity costs accounts for our passions and preferences negative profits mean we're giving up some other opportunity that would actually leave us better off So eventually we will call it quits if negative economic profits persist let's summarize that information the short run some of your costs are fixed and you've already paid them and so it might make sense to stay in operation even if you aren't able to make enough money to cover those fixed costs and end up losing money overall the rule here is that so long as total revenue is greater than total variable cost stay in business until you get to the long run obviously if total revenue is greater than total cost you're golden you're paying off your fixed costs and you have something left over but if it isn't going well you want to try to pay back as much of those fixed costs as possible so long as you're making more than your variable costs you'll be eating into those fixed costs if you aren't making enough to cover those variable costs though it's time to shut down because producing more just means digging a deeper hole for yourself the long run is the time it takes for your fixed costs to become flexible and this is where firms make go no-go decisions for staying in business if profits are positive meaning the price exceeds the average cost of production then you want to be in business and more firms are likely to join because positive economic profits indicate that this is a more profitable Enterprise than comparable alternatives but if profits are negative even just slightly then it's time to shut down and go do something else this would happen if the price is less than average cost and it indicates that there are similar opportunities that pay more which you should switch to I suspect that you aren't finding this very surprising if businesses are making lots of money it will attract competitors if they aren't only the most efficient firms Will Survive and others will move on to other things this is pretty straightforward but it's very powerful when you consider how it all adds together firms enter and exit based on whether or not the price they sell their product for is greater than or less than the average cost of production we don't have a complete theory of where prices come from yet but for all we've said so far firms just pick a press for their product but soon we'll see that markets set prices and those prices direct resources to different uses when prices are high firms jump into that industry and bring their resources with them producing something that consumers are willing to pay a lot for when prices are low resources are scared away to other more profitable uses rather than being wasted on something that people aren't willing to pay very much for as we continue to build a theory of prices you'll want to keep in mind how firms react to them and what that means for how our resources get used