Economists Do It With Models

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Cartoon Of The Day: Why People Should Take Economics Before Starting A Business…

February 21st, 2011 · 17 Comments
Decision Making · Econ 101

I feel like I’ve had conversations like this with people before. From Giant in the Playground:

(HT to Jonatan Krovitsky)

Dear world: if you want to run a profitable business, you have to focus on, well, profit. And, by the way, revenue and profit are not the same thing…and, no, units sold and profit are not the same thing either. (If this were true, it would always be an optimal strategy to give away your product for free or even pay people to take your product, right?) I remember going into a Dunkin Donuts a couple of years ago and seeing a sign that said something along the lines of “we apologize, but we have to raise prices to make up for lost sales due to the bad economy.” I think it was only the fact that I was hungover that prevented me from pointing out to the cashier that her employer was totally doing it wrong. In case you’ve forgotten:

In related news, I have finally fully gotten over my long-standing distaste for The Big Bang Theory- I think it has something to do with the fact that the show had Danica McKellar on one episode and now has Mayim Bialik as a recurring character. (Yep, Blossom both has a Ph.D. in neuroscience and plays one on TV. And yes, I realize that the show is totally pandering to people like me, but I’ll take it.) As such, I was watching an episode the other day that teaches an important lesson about productivity and economic profit:

Penny: Yeah, yeah, yeah, yeah. Look, look, look! I started a business.

Sheldon: Obviously, not a cleaning business.

Penny: No, I’m making flower barrettes. See? I call them Penny Blossoms. I made one for myself, then all the girls at work wanted one. Then I showed some to this lady who runs a shop in Old Town. She sells cards and homemade jewellery. She said she wanted to sell them. I said okay, and in one week, I made a $156.

Sheldon: Good for you. Sign here.

Penny: Sheldon, don’t you get it? If this takes off, I won’t have to be a waitress anymore.

Penny: So, what do you think? I mean, this could be a business, right?

Sheldon: How many of these can you make a day?

Penny: About twenty.

Sheldon: And how much profit do you make per Penny Blossom?

Penny: I don’t know, like, 50 cents. I’m not sure.

Sheldon: No, Of course you’re not. All right, ten dollars a day times five days a week times 52 weeks a year is two thousand six hundred dollars.

Penny: That’s all?

Sheldon: Before taxes.

Scene: Penny’s apartment. Penny is making a barette. Sheldon is timing her.

Penny: There. Done.

Sheldon: All right. 12 minutes and 17 seconds.

Penny: Pretty good, right?

Sheldon: That’s 4.9 Penny Blossoms per hour. Based on your cost of materials and your wholesale selling price, you’ll effectively be paying yourself… $5.19 a day.

Penny: A day?

Sheldon: There are children in a sneaker factory in Indonesia who outearn you.

Leonard: I can’t believe we actually did it.

Howard: 1,000 friggin’ Penny Blossoms.

Penny: I just want you guys to know I am really grateful for your help, and for every dollar I make, I’m going to give you 20 cents.

Howard: That’s your entire profit margin.

Penny: Oh. Then never mind.

You can see the full transcript here, and a video of the first part is available here.

I would like to take this opportunity to remind everyone of the difference between accounting profit and economic profit. Accounting profit is simple- dollars in minus dollars out. In this case, Penny at least has an accounting profit since she is selling the penny blossoms for more than it cost her to make them. Economic profit, on the other hand, is a different story, since economic profit factors in opportunity cost. If Penny makes, say, $30,000 per year as a waitress, then she has an opportunity cost of $30,000 if she decides to quit her job to make penny blossoms. Given this, she is not likely to make an economic profit unless she becomes much more productive, since her $2,600 of accounting profit isn’t enough to cover her opportunity cost as well.

This is a good example of why economic profit rather than accounting profit is the right quantity to consider when making business decisions. When I see things like this, I can’t help but think of a friend of mine from high school who quit her job to open an Etsy store, among other things. (And yes, when I visited her last year, I did ask lots of questions of the “how long does it take you to make this stuff?” variety.) Luckily, The Big Bang Theory appears to have been somewhat educational for this demographic:

I kept thinking of Etsy and all the small shop owners here. Penny was quite excited that the girls where she works wanted some of her clips and a lady with a boutique wanted to carry them. “I made $156 this week, Sheldon!” “If this really takes off I won’t have to be a waitress all my life.”

Sound familiar? I know I daydream about my shop taking off to full time income status. Sheldon had to be the voice of reason though. “Penny, how much do you make on each Penny Blossom?” Her reply, “I dunno.” “Of course you don’t.” Now, Sheldon is a physicist and is all about hard numbers, but this conversation was one I’ve seen many times on the forums here.

It’s hard to know if you can make a living until you figure out your production time, profit per piece, and workable hours per week/month/year.

As the show progressed the techie friends had built Penny a storefront online (I’m thinking “Go to Etsy!”) and then the real trouble began. A huge order of 1000 Penny Blossoms…. with a 1 day rush service. Rut roh!

The Penny Blossoms did get done with the help of friends, refined manufacturing process to significantly reduce production time, work chanting songs, and coffee.

I know it was just a sitcom, but I highly recommend it to all Etsy sellers. Very funny and actually hit on a lot of the issues we all face here, especially when starting up or trying to take our shops to the next level.

Hope I wasn’t the only one who saw it and though immediately of my own Etsy shop.

As your humble blogger, I would like to be the pot rather than the kettle, thanks.

Tags: Decision Making · Econ 101

17 responses so far ↓

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  • 2 Steve // Feb 21, 2011 at 7:39 pm

    There is another episode where they bring up economics which was rather good:

    Howard (on the phone): Yeah, I miss you, too, sweetie. Listen, I got to go, but I’ll see you tonight? Okay. Bye-bye. Yeah, bye-bye. No, you hang up first. Hello?

    Raj: Dude, I’m glad you finally got a girlfriend, but do you have to do all that lovey-dovey stuff in front of those of us who don’t?

    Sheldon: Actually, he might have to. There’s an economic concept known as a positional good in which an object is only valued by the possessor because it’s not possessed by others. The term was coined in 1976 by economist Fred Hirsch to replace the more colloquial, but less precise neener-neener.

    Howard: That’s not true. My happiness is not dependent on my best friend being miserable and alone.

    Raj: Thank you.

    Howard: Although, I’d be lying if I said it wasn’t a little bit of a perk.

    Leonard: Who’s miserable and alone?

    Raj: Me.

    Leonard: Oh. I used to be like that. Then I got a girlfriend.

    Sheldon: In pre-1976 terms, neener-neener.

  • 3 Harold // Feb 22, 2011 at 12:09 am

    Great Blog! One thing, a change in price at Dunkin Donuts would not shift the demand curve to the left as the graph suggests. A change in price, in this case, would mean there would be movement along the original demand curve to the north and west.

  • 4 econgirl // Feb 22, 2011 at 1:44 am

    @ Steve: One step ahead of you:

    @ Harold: Of course. I didn’t mean to imply that. What I meant was that the reduction in demand (presumably due to a reduction in income in income or consumer confidence) will, in equilibrium, lower prices, but the company was naively thinking that they could do better by moving prices in the opposite direction.

  • 5 John // Feb 22, 2011 at 4:33 am

    The following business properties get me in a hot dense state …

    High return on equity
    No debt
    Good Profit
    Good quality business
    Positive cashflow
    Significant discount to intrinsic value
    Intrinsic value rising at a good rate
    Good prospects

    Love the blog, love the Big Bang Theory, love WB.

  • 6 BradyDale // Feb 22, 2011 at 11:16 am

    On selling at a loss: don’t big stores do this for certain products all the time on the correct assumption that folks will buy other stuff to make up the difference? This comic kind of screws it up by saying everything is the same price.

    But… if people typically only buy ONE of the potion A, for 20gp, but it costs 25gp.
    But… everyone always buys a few potion Bs, any time they go to the potion store, for 5gp, but it only costs 3gp to make,
    you start to see how it works.

    Selling certain attractive products at a loss can drive foot traffic so that you really see your profit go up.

    Also, on donuts: isn’t there a chance that demand for donuts isn’t very elastic? Lots of people get a coffee and a donut every morning and call it breakfast and they aren’t going to stop if the price of donuts go up a quarter?

    I know I worked for an office that bought a box of donuts for every meeting. I don’t think they would have stopped because the price of a box went up $1.50.

    Just a thought.

  • 7 econgirl // Feb 22, 2011 at 12:42 pm

    You’re not wrong on the first point, which is why the comic specifically rules out that possibility. I am reasonably confident that there are businesses out there who think they are implementing the loss leader concept as you describe it but are either actually selling everything at a loss or not making enough profit on the profitable items to make the loss leaders worthwhile.

    On the second point, if demand was inelastic enough that it was profitable to raise prices, why didn’t it do so before the bad times hit? 🙂

  • 8 BradyDale // Feb 22, 2011 at 12:50 pm

    @econgirl on elasticity (even when I was taking micro, I could never keep the two straight. I know what they mean, but which is elastic and which is inelastic… don’t ask me) Fair point. It always bums me out that so few people understand that they could make more money by charging lower prices (e-comic-book industry – please listen).

  • 9 Warren // Feb 22, 2011 at 2:26 pm

    Sounds like Dunkin Donuts is getting business advise from the U.S. Postal Service.

  • 10 A Weekly Round-Up of Small-Business News - // Feb 28, 2011 at 8:04 am

    […] KIND OF PROFIT ARE YOU MAKING? The economist Jodi Beggs explains why entrepreneurs should study economics before starting a business: “Accounting profit is simple — dollars in minus dollars out. Economic profit, on the other […]

  • 11 Why People Should Take Economics Before Starting A Business… « Daniel Smith // Feb 28, 2011 at 6:18 pm

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  • 12 Cartoon Of The Day: Why People Should Take Economics Before Starting A Busines | My Blog // Feb 14, 2012 at 8:08 pm

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