Gus is set on controlling the market for meth in the Southwest. He has worked hard to eliminate the local drug cartel so that he can be the sole supplier. Being the only supplier of a product gives a firm market power to charge prices greater than marginal cost. While profit maximization still occurs where marginal cost equals marginal revenue, a firm with market power is able to charge a markup on top of the marginal cost. Further, the markup is inversely proportional with the price elasticity of demand coefficient (i.e. the more inelastic the demand, the higher the markup). As the number of substitutes (competitors) decreases, the demand for each firm becomes more inelastic, which, in turn allows the firm to charger higher prices.
The price system motivates Gus to purchase the equipment for the chemistry lab, hire the resources needed and take the risk to produce and distribute the methamphetamine. Gale is shocked by the investment, but profit motives are often used as the incentive for investments. Firms only invest in resources if they believe they can lower the cost of production (given a fixed output) or to increase production either of which would increase profits.
Gale is asked to test the purity of Walt’s meth and finds that it’s 99% pure, while he can only produce a version that is 96% pure. From Fring’s standpoint, 96% is good enough, but Gale is impressed that another chemist can achieve a 99% purity level. It is apparent that Gus weighs the costs and benefits of producing 99%- or 96%- pure methamphetamine. After all, the equipment he just purchased is suited for producing both purities, which makes the two varieties substitutes in production. Nevertheless, Gus decides that a purity of 96% will suffice. From his perspective, the cost of working with Walter, who is regarded as unprofessional, outweighs the 3-percentage points increase in the purity of the drug. However, Gus’ methamphetamine, although 96% pure, is inferior to that of Walter and the logic of the Alchain-Allen theorem tells us that he might be losing out as long as it competes with the “blue” drug. In other words, the Alchian-Allen theorem states that, when the same transportation, distribution, tax, or sale-specific markup is added to the prices of two similar varieties of the same product, the relative consumption of the higher quality good will increase. Since from a legal perspective, the risks and costs of distributing methamphetamine are, more or less, the same, regardless of its purity, a relatively larger market share will be accounted by Walter’s “blue” methamphetamine. The scenes within the video clip are also useful for discussing product differentiation as a key characteristic of monopolistically competitive markets. The blue color of Walter’s methamphetamine represents a signal of quality as well as purity that bridges the seller- buyer information gap, a problem that plagues black markets such as those for drugs and other illicit goods or services.
This description comes from Duncan, Muchiri, and Paraschiv (Forthcoming)
Gus and Mike have both been shot. However, the personnel at temporary medical facility they found themselves in only focus on saving Gus. Jesse is frustrated by this because Mike and he are very close. Nevertheless, the doctor points out that Gus is the priority because he is the one paying his salary. This is also visible in our current medical system. Specifically, those who have the ability to pay often receive priority and extra-quality healthcare, which may not be equitable, but may be, perhaps, efficient.
Gus and his people leave the meeting at the hospital with Jesse and head back to their car in the parking garage. As they approach the car, Gus stops and begins to look around at the rooftops around the garage. Walter is on a nearby rooftop and hides as Gus stands right across from him waiting and thinking. He decides to abandon his car, as he fears it may be a trap.
Gus Fring confuses the DEA chief, George Merkert, because when he invited him over to his house and Fring seemed like a good person. However, it turns out that people can hide who they really are and appear to be what others want them to be. Fring knew the entire time that he was manufacturing large quantities of methamphetamine and yet he was having dinner with his potential captor. This clip represents a starting point for a discussion about asymmetric information, which occurs when one party holds relatively more information about an exchanged good.
After joining forces with Gus Fring, Walter learns about his new lab. The production facility is state of the art and includes some of the best equipment available on the market. This new equipment will allow Walt to produce even more of his blue meth than he could have previously imagined. Economies of scale are important in the production process. As facilities grow, their organization can begin producing large quantities, which lowers the average cost of production.
Gus and Walter discuss Walter’s decision to start cooking meth. Walt has debated the costs and benefits of his decisions throughout the show’s five seasons. Gus has an incentive to make sure Walter produces for him, so he tries to emphasize the importance of the benefits Walt has received and echoes how large those benefits are relative to the costs.
In this ad for Los Pollos Hermanos, the narrator speaks of the importance of quality in the production process. Higher quality inputs imply a higher quality of output, whether it’s rotisserie chicken or crystal meth. Walter uses only the finest ingredients, in a state-of-the-art facility to produce the most popular version of meth on the market. This scene highlights the relationship between inputs and outputs in the production process.
The video clip is also helpful for discussing the principal-agent contract. More specifically, the clip presents Gus Fring as he supervises the packaging and loading of methamphetamine into trucks for distribution purposes. Gus is the owner of Los Pollos Hermanos, the man running the methamphetamine production operation, and therefore the principal. The laborers packaging the methamphetamine and the truck drivers transporting it are the agents. Sometimes agents do not act in the principal’s best interest. This behavior is also known as shirking, and one can prevent or limit it through adequate monitoring activities, which is precisely what Gus does.
This description adaptaed from Duncan, Muchiri, and Paraschiv (Forthcoming)
It’s time for Walter to quit so he stops by to visit Gus Fring. Gus wants to offer Walter 3 million dollars to keep making his blue meth for 3 more months, but even that amount isn’t worth it to Walt. Walter is trying to piece his life back together and believes that continuing to produce his blue meth isn’t worth the amount he’s giving up. Walter admits to Gus that he has more money than he knows what to do with. Even for the wealthy, there’s diminishing returns to acquiring more income.
The Economics of Breaking Bad 