Marginal Cost
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Transcript Marginal Cost
THE STUDY OF INDIVIDUAL CHOICES CONCERNING THE
USE OF RESOURCES AMONG COMPETING WANTS TO
MAXIMIZE WEALTH
Scarcity
All resources are limited
So, people cannot obtain all that they want
they must make a sacrifice
or in more economic terms, “Pay a Cost”
Scarcity forces YOU to choose among alternatives
Resources – What are they?
Land
Human capital (Labor)
Physical capital
Entrepreneurship
Economics – a way of analyzing
choices concerning use of resources
Ultimate Goal of Economics: Maximize individual and
societal wealth
Wealth is the subjective evaluation of well being
Economic thinking can be used to maximize your own individual
wealth.
Economics can be used for social policy to maximize wealth for all
members of a society.
Here’s the Deal
Resources are insufficient to satisfy our
unlimited wants.
“We can’t have everything we want.”
We must make choices – inevitable reality
Choices require decisions between
alternatives
Alternatives create winners and losers
So we should be careful about the choices
we make.
Benefit/Cost Analysis
State the goal and identify the resources
available to reach the goal.
Identify alternative ways to use the resources to
achieve the goal.
Narrow the alternatives to two. Evaluate the
advantages and disadvantages of each
alternative.
Select the best choice, based on available
information
The choice not selected is called the opportunity
cost.
Keep in mind
The choice is the alternative selected.
The opportunity cost is the alternative not
selected, the opportunity given up.
Every choice has a cost; there is no such
choice as a free choice.
DISADVANTAGES ARE NOT COSTS.
There is only one cost to each choice.
Marginal
A little more or a little less. Compare benefits
and cost of two alternatives
The Solution: Marginal Analysis
Every resource use has a benefit and an
opportunity cost.
We should only use the resource in that activity if
the benefit outweighs the OC.
Marginal analysis tells us how much of each
resource to use in each activity.
Using Marginal Benefit/
Marginal Opportunity Cost Analysis
Investigating two alternatives
What’s the difference in benefits between
the two?
Is the marginal benefit of the choice
greater than the marginal OC?
The Marginal Principle
How far should I pursue any single activity,
knowing that the resources I am using have
opportunity costs; they could be doing other
things? Ex. You can’t please everyone
If the marginal benefit is greater than the marginal
opportunity cost, go for it; otherwise, go back!
Using Marginal Analysis
How long should I wait in the lunch line?
As long as the marginal (additional) benefit of getting hot lunch
outweighs or is MORE than the marginal cost of time lost with
friends.
As long as MB (Marginal Benefit) is > MC (Marginal Cost)
How long should I continue dating my boyfriend?
As long as the marginal (additional) benefit of seeing him is
greater than the marginal (additional) cost of seeing better
guys.
MB > MC
How long should I study for the unit test?
As long as the marginal (additional) benefit of studying is
MORE than the marginal cost of no sleep.
MB > MC
Opportunity Cost
Use opportunity cost to explain the following
Why farmers often wait until a rainy day
to do errands in town, while a
businessman in a new suit will decide to
forego his errands on the same day.
The opportunity cost (OC) for a farmer
doing errands in town on a rainy day is
lower than the OC for a businessman
doing errands in town on the same day
Why businessmen often buy full-fare
tickets while people planning vacations fly
when rates are lower
The opportunity cost for a businessman
buying full-fare tickets is higher than that of
a family planning a vacation
Why movie stars, fashion models and rocksingers have higher divorce rates than the rest of
the American population
The opportunity cost for a rock star getting
divorced are lower than the opportunity cost are
for the rest of the American population to get
divorced
Law of Diminishing Returns
Output will ultimately increase by progressively
smaller amounts when the use of a variable
input increases while other inputs are held
constant
*The point at which spending more time will
result in lesser return
Example
Ms. Joy decides to start a zucchini garden
Year 1 she harvests 20 zucchini!
Year 2 she uses 1 pound of fertilizer which results in 30 zucchini!!
Year 3 she uses 2 pounds of fertilizer 35 zucchini
Year 4 she uses 3 pounds of fertilizer 37 zucchini
Year 5 she uses 4 pounds of fertilizer 33 zucchini – less than
before…hmmmmmm
Year 6 she uses 5 pounds of fertilizer 5 zucchini…all the rest were
killed before flowering
The Principle of
Exchange
People will exchange if they gain more than they
give; if the value of the choice is greater than the
opportunity cost.
How do we get what we want?
Scarcity causes goods and services to be
rationed
How do we do this?
Who decides on the mechanism?
Rationing Methods
First-Come, First-Served
Merit or Need
Arbitrary - Age, Hair Color, Shoe Size
Price--a Market System
Advantages of a Price System
Anonymous - Participants may not know each
other’s characteristics
Market provides variety
Compare relative prices (i.e., opportunity cost)
Common Currency - No question of value
Individual choice to participate
The Market
One way to allocate scarce goods and services
Relative prices: why?
$50,000
$5
Because Scarcity Exists:
Scarce goods have to be rationed.
Some folks will be told “NO!!!”
It’s not fair, everyone will not be happy.
Price: unit by which we measure
relative scarcity
Order these products in terms of
relative scarcity
a candy bar
a yacht
a Toyota mini truck
a nice dinner for two in LA
a ticket to a professional baseball game
dinner for one at MacDonald’s
a laptop computer
Order these products in terms of
relative scarcity
7 a candy bar
1 a yacht
2 a Toyota mini truck
4 a nice dinner for two in LA
5 a ticket to a professional basketball game
6 dinner for one at McDonald’s
3 a laptop computer
Price
The measure of relative scarcity
If a product becomes relatively more
scarce, the price will rise.
If a product becomes relatively less scarce,
the price will fall.
Market: An interaction of buyers
and sellers
Necessary Components for a Market
Competition
Information
Property Rights
Incentives
Property Rights
With well defined property rights, owners have
incentives to preserve, develop, and improve
resources
Without well defined property rights, people
have incentives to use resources as quickly as
possible
over fishing
The buffalo
Economic Systems
Three Economic Questions
1. What goods will be produced
- What does an economy need to produce to keep its
people alive/happy?
2. How will the goods be produced
- Should government produce things?
- Should things be produced by private citizens?
- Why?
3. Who gets what is produced
- Will everyone automatically get what is
needed?
- How will you decide who gets what?
Three Types of Economic Systems
1. Traditional Economy
- economic decisions made based on tradition,
customs, cultural beliefs
- self-sufficient, pre-industrial groups
- little or no outside trade – barter system
2. Command Economy, Socialism
Government ownership of all means of
production – all business (factories, farms)
-The “THEORY”
Everyone contributes according to their
ability and receives according to their need
Advantages of Socialism
- guaranteed employment
- guaranteed housing
- free education
- free medical care
Disadvantages of socialism
- little incentive to work hard (why??)
- inefficient methods of production (more jobs)
- inhibits innovation, creativity (no self-interest)
- consumer has little choice (no competition)
3. Market Economy, Capitalism, Free Enterprise
System
- all business decisions are made by business
owners and consumers
- all decisions based on self-interest
Self-interest is the motivator
- competition is essential
Competition is the regulator
- property rights are protected
- prices fluctuate based on interaction of supply
and demand
Advantages of capitalism
- hard work is rewarded
*overtime pay, raise, promotion
- innovation is encouraged – increase profit
- flexibility – change happens easily
- quality goods are produced and sold at a
fair price (competition)
Disadvantages of capitalism
- unequal distribution of income
*few rich, some middle, some poor
- financial insecurity bankruptcy, unemployment
- high cost of education, health care
- subject to inevitable swings of the Business Cycle
Reality Check
Modern national economies are all a mix of some
capitalism and some socialism – Mixed Economies
United States - minimum wage, social security,
medicare, anti-monopoly legislation
China – encourages individuals to own businesses
and make profit
North Korea – closest to pure socialism