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.
Walter, Jesse, and Mike and splitting the proceeds from a new, methamphetamine-production business. The scene demonstrates how businesses incur various expenses while providing instructors and students with a lively example about the different cost types. Once Mike divided the revenue into three equal stacks, he goes on to do an accounting of all the costs they have incurred while producing their latest batch. One can observe that some the costs such as the ongoing expense with keeping former collaborators quiet are fixed, while others, such as the cut to the dealers or the fee for the drug mules (i.e., those who transport the methamphetamine from its production to distribution location) are variable. Actually seeing each pile of cash shrinks, as they account for the costs of the business, provides a visceral example about costs, profit, and the relationship between the two.
This clip may also serve as a catalyst for discussing, once again, the role of institutions in shaping the behavior of economic agents and the consequences brought about by their lack of reach into black markets such as that for methamphetamine. Walter is surprised to find out that the cost with the mules is 20% of the revenue. However, Mike adds that transporting the methamphetamine involves risks (i.e., of being robbed by a rival gang or being caught by the police and sent to jail) and the cost is justified – in economics jargon, such costs represent the compensating differential for hazardous work conditions. Outside black markets, a robbery is solved by simply reaching out to the police or other specialized authorities. In other words, property rights may be enforced through the judicial system. However, in the case of methamphetamine this is not possible. This way, those who move the drug must also guard it and enforce the property rights over it through violence. Hence, the steep cost of transportation that characterizes the methamphetamine-producing business.
This clip also provides a detailed account of various activities that form the underground economy and underpin the $1,392,800, methamphetamine business. For example, dealers receive $13,240, mules (the ones who transport the methamphetamine for distribution purposes) get a flat 20% (after the dealers have been paid) or about $278,560, miscellaneous production-related expenses total $120,000, expenses with concealing the laboratory add up to $165,000, while the lawyer/money-laundering fees are $54,000. As part of the methamphetamine production, all these activities are illegal, thus not recorded officially, and hence part of the underground economy. The figures associated with such activities may find their way into official data, however, as fictional activities/services conjured by money launderers. This illustrates once more the difficulty that arises from accurately measuring the volume of the economy be it as the gross domestic or gross national product.
This description comes from Duncan, Muchiri, and Paraschiv (Forthcoming)
After running out of their primary ingredient, Mike suggests that they go back to producing using pseudoephedrine. Walter quickly points on that their equipment isn’t designed for this and it will reduce their yield significantly. Mike argues that the alternative is not making anything at all and that making some product is better than making no product at all. This scene serves as a nice example of why firms may operate at a loss rather than shut down. As long as the price of the product is greater than average variable costs, firms will operate in the short run.
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.
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)
Jesse calculates that Fring is earning $93 million from Jesse and Walter producing meth, but he doesn’t feel adequately compensated. His focus on Fring’s revenue rather than his profits is causing him to feel vastly underpaid. What is Jesse forgetting? What about costs with the lab, packaging, distributing, and guarding the meth. In addition, the risk that Gus (the owner of the methamphetamine operation) takes represents an additional cost of doing business.
In a flashback to the pilot episode, Jesse and Walter are discussing the purchase of an RV to start cooking meth. The purchase of the famous RV would represent a fixed cost of production for their new business venture
Jesse brings in the revenue from the first batch of meth, and Walter is less than impressed with the amount of money that has come in. Walter had made a pound of meth (16 ounces), but Jesse has only sold 1 ounce because he’s selling it directly to users. Walter isn’t happy with the payoff because he feels the risk he is taking by breaking the law should result in a lot more profit. The two brainstorm ways to sell in larger quantities, but it turns out they had earlier killed the one person they knew who would be buy in bulk. By selling in larger quantities, the two can lower their average fixed costs (economies of scale), but it also means that they’re going to have to find a partner to do that because Jesse doesn’t have a big enough footprint to sell that much dope.
Jesse and Walter debate on the best way to start the business. At first, Walter is surprised that Jesse doesn’t want to cook in the garage, but Walter is just as reluctant to cook at his house. The two consider renting a storage unit, but eventually settle on purchasing a recreational vehicle. When starting a business, companies must decide whether to start by renting property, which may have lower costs initially or building and owning their own property.
There are tradeoffs to the two, and this situation is explored often in the decision for young adults to continue renting or purchasing their own home. The clip also serves as a good introduction to risk and uncertainty. Although it would be cheaper to begin production in their own homes, it is also VERY risky. Safe options often mean spending more money upfront.
The Economics of Breaking Bad 