MARGINAL ANALYSISANALYSIS MARGINAL COST V. MARGINAL BENEFIT Take out Module 8 Notes

OBJECTIVES  To understand and distinguish between the two types of economic decisions: “either-or” decisions and “how much” decisions.  To understand the method of economic decision making: weighing the costs and benefits of any activity before undertaking that activity.

“EITHER-OR” OR “HOW-MUCH”? a. The state government is considering whether to build a public library or a new elementary school. “either–or” decision b. Executives at Apple Computer are debating whether or not to produce an additional 300,000 i-Phones this year. “how-much” decision c. You have been accepted into the Peace Corp and will be posted to the Czech Republic. You must now decide whether to join the Peace Corp or to go school full time at Arizona State University. “either–or” decision d. You are deciding whether to cut back your 30-hour work week to 20 hours so that you can take an evening class at your local college. “how much” decision e. The price of tuition at your community college has gone up. You’re considering taking less units. “how much” decision

MARGIN  The margin is defined as “the next step”; it could be an incremental step (a little bit more) or a decremental step (a little bit less).  The principle of marginal analysis is used to answer the “how-much” question.

MARGINAL ANALYSIS INVOLVES COMPARING:  The benefit from that next step which is called Marginal Benefit WITH  The cost of taking the next step which is called Marginal Cost

MARGINAL ANALYSIS  If Marginal Benefit > Marginal Cost   The activity yields a Net Marginal Benefit  If Marginal Benefit < Marginal Cost   The activity yields a Net Marginal Cost  If Marginal Benefit = Marginal Cost   You have reached the optimal quantity

THE RULE OF MARGINAL ANALYSIS The optimal quantity is the quantity at which: Marginal Benefit = Marginal Cost or Marginal Benefit ≥ Marginal Cost

8 APPLYING MARGINAL ANALYSIS Example 1: Jerry owns a candy store. The store's revenues depend on the number of hours the store is open each day as shown in the Table below. The cost of staying open each hour is $10. If Jerry follows the marginal principle, how many hours each day should he keep his store open? Hours Open Total Revenue (Total Benefit) $

9 9 Hours Open Total Revenue (Total Benefit) $ Marginal Benefit (∆ Total Benefit) $ Step 1: Determine what is the marginal benefit? The marginal benefit is the marginal revenue or incremental revenue. Solving the problem

10 Hours Open Total Revenue (Total Benefit) $ Marginal Benefit (∆ Total Benefit) $ Marginal Cost $ 0$ Step 2: What is the marginal cost? The marginal cost is what Jerry has to pay to keep the store open for each additional hour.

11 Hours Open Total Revenue (Total Benefit) $ Marginal Benefit (∆ Total Benefit) $ Marginal Cost $ Net Marginal Benefit/Cost $ 0$ = = – – –7 Step 3: Compare the marginal benefit and the marginal cost for each hour that the store is open to determine if Jerry should keep it open.

12 Hours Open Total Revenue (Total Benefit) $ Marginal Benefit (∆ Total Benefit) $ Marginal Cost $ Net Marginal Benefit/Cost $ = = – – –7 The optimal number of hours is 4. For the 4 th hour, marginal benefit equals marginal cost.

HOW MUCH OF A PARTICULAR ACTIVITY? KNOW WHEN TO MOVE ON.  Pursue activities as long as the marginal benefit exceeds the marginal opportunity cost.  Pursue activities up to the point where MB = MOC.  If the marginal benefit of another unit of the activity is greater than the marginal opportunity cost, go for it!  If the marginal benefit of another unit of the activity is less than the marginal opportunity cost, stop!

CLEANING YOUR ROOM  Your room is dirty.  Let’s clean it.  How clean?  What are the benefits of different degrees of clean?  What is the marginal opportunity cost? 