251FINA Chapter Two Dr. Heitham Al-Hajieh

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Presentation transcript:

251FINA Chapter Two Dr. Heitham Al-Hajieh

Marginal analysis Marginal benefit = additional benefit resulting from a one-unit increase in the level of an activity Marginal cost = additional cost associated with one-unit increase in the level of an activity

Net benefit Individuals are not expected to maximize benefit; nor are they expected to minimize costs. Individuals are assumed to attempt to maximize the level of net benefit (total benefit minus total cost) from any activity in which they are engaged.

Marginal analysis MB > MC  expand the activity MB < MC  contract the activity optimal level of activity: MB = MC (Net benefit is maximized at this point)

Marginal benefit MB generally declines as the level of an activity rises, ceteris paribus. Consider the MB of time spent studying:

Marginal cost For most activities, marginal cost rises as the level of the activity increases.

Optimal study time The optimal amount of study time occurs at the point at which MB = MC

Production possibilities curve Assumptions: A fixed quantity and quality of available resources A fixed level of technology Efficient production (i.e., no unemployment and no underemployment)

Example: study time 4 hours left to study for two exams: economics and calculus Output = grades on each exam Fixed resources? Fixed technology? No unemployed nor underemployed resources?

Alternative uses of time

Law of diminishing returns 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. Does this apply in this example? What are the fixed inputs?

Production possibilities curve

Marginal opportunity cost Marginal opportunity cost = the amount of another good that must be given up to produce one more unit of a good.

Calculating marginal opportunity cost In the interval between points A and B, the marginal opportunity cost of 1 point on the economics exam is 1/3 of a point on the calculus exam.

Marginal Opportunity Cost (continued) In the interval between points B and C, the marginal opportunity cost of one point on the economics exam equals 4/3 of a point on the calculus exam.