Economic Decision Making and Module 1 Economic Decision Making and Marginal Analysis

Objectives To understand and distinguish between the two types of economic decisions: “either-or” decisions and “how much” decisions.

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.

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. To understand and apply the principle of marginal analysis used in making “how-much” decisions.

Objective 1 To understand and distinguish between the two types of economic decisions: “either-or” decisions and “how much” decisions.

Objective 1: … distinguish between the “either-or” decisions and the “how much” decisions. a. The state government is considering whether to build a public library or a new elementary school. Take a look at the black text as in “d’ and “e”. Which do you like better> I like e better. The transition should look like so: “a’ comes on first without the “either-or’. Then the “either-or” appears when I say it. “a” remains on the screen, then b comes on without the “either-or”, then the either comes on and so forth.

Objective 1: … distinguish between the “either-or” decisions and the “how much” decisions. a. The state government is considering whether to build a public library or a new elementary school. “either–or” decision Take a look at the black text as in “d’ and “e”. Which do you like better> I like e better. The transition should look like so: “a’ comes on first without the “either-or’. Then the “either-or” appears when I say it. “a” remains on the screen, then b comes on without the “either-or”, then the either comes on and so forth.

Objective 1: … distinguish between the “either-or” decisions and the “how much” decisions. 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. Take a look at the black text as in “d’ and “e”. Which do you like better> I like e better. The transition should look like so: “a’ comes on first without the “either-or’. Then the “either-or” appears when I say it. “a” remains on the screen, then b comes on without the “either-or”, then the either comes on and so forth.

Objective 1: … distinguish between the “either-or” decisions and the “how much” decisions. 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 Take a look at the black text as in “d’ and “e”. Which do you like better> I like e better. The transition should look like so: “a’ comes on first without the “either-or’. Then the “either-or” appears when I say it. “a” remains on the screen, then b comes on without the “either-or”, then the either comes on and so forth.

Objective 1: … distinguish between the “either-or” decisions and the “how much” decisions. 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. Take a look at the black text as in “d’ and “e”. Which do you like better> I like e better. The transition should look like so: “a’ comes on first without the “either-or’. Then the “either-or” appears when I say it. “a” remains on the screen, then b comes on without the “either-or”, then the either comes on and so forth.

Objective 1: … distinguish between the “either-or” decisions and the “how much” decisions. 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. Take a look at the black text as in “d’ and “e”. Which do you like better> I like e better. The transition should look like so: “a’ comes on first without the “either-or’. Then the “either-or” appears when I say it. “a” remains on the screen, then b comes on without the “either-or”, then the either comes on and so forth.

Objective 1: … distinguish between the “either-or” decisions and the “how much” decisions. 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. 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. Take a look at the black text as in “d’ and “e”. Which do you like better> I like e better. The transition should look like so: “a’ comes on first without the “either-or’. Then the “either-or” appears when I say it. “a” remains on the screen, then b comes on without the “either-or”, then the either comes on and so forth.

Objective 1: … distinguish between the “either-or” decisions and the “how much” decisions. 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. 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. Take a look at the black text as in “d’ and “e”. Which do you like better> I like e better. The transition should look like so: “a’ comes on first without the “either-or’. Then the “either-or” appears when I say it. “a” remains on the screen, then b comes on without the “either-or”, then the either comes on and so forth.

To understand the method of economic decision making Objective 2 To understand the method of economic decision making In both types of decisions -- the “either-or” and the “how-much” decision -- the rational decision maker weighs the costs and benefits of each activity.

Objective 2: … the method of economic decision making The first step in evaluating an economic activity is to identify the relevant benefits and costs.

Objective 2: … the method of economic decision making The first step in evaluating an economic activity is to identify the relevant benefits and costs. For example, if the state government has to decide between building a public library and a new elementary school, it must first evaluate the total costs and total benefits of each project and then allocate funds to the project that yields the highest net benefit.

Objective 2: … the method of economic decision making The first step in evaluating an economic activity is to identify the relevant benefits and costs. For example, if the state government has to decide between building a public library and a new elementary school, it must first evaluate the total costs and total benefits of each project and then allocate funds to the project that yields the highest net benefit. For either-or decisions, the relevant costs and benefits are the total costs and total benefits.

Objective 2: … the method of economic decision making What about the “how-much” decision?

Objective 2: … the method of economic decision making What about the “how-much” decision? The relevant costs and benefits are the marginal or incremental costs and the marginal or incremental benefits.

Objective 3 To understand and apply the principle of marginal analysis used in making “how-much” decisions. Marginal analysis is a methodology used to answer the “how-much” question. 20

Objective 3: … the principle of marginal analysis 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). 21

Objective 3: … the principal of marginal analysis Marginal Analysis involves comparing the benefit of taking the next step with the cost of taking that next step. The three lines; The benefit…. (2) with The cost… (3) In marginal analysis… comes on one at a time.

Objective 3: … the principal of marginal analysis The benefit from the next step is called the Marginal Benefit The three lines; The benefit…. (2) with The cost… (3) In marginal analysis… comes on one at a time.

Objective 3: … the principal of marginal analysis The cost of taking the next step is called the Marginal Cost. In marginal analysis, the decision maker weighs the marginal benefit against the marginal cost before deciding whether to pursue the activity. The three lines; The benefit…. (2) with The cost… (3) In marginal analysis… comes on one at a time.

Objective 3: … the principal of marginal analysis If Marginal Benefit > Marginal Cost  The activity yields a Net Marginal Benefit Do Not Confuse net marginal benefit with marginal benefit 25

Objective 3: … the principal of 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 26

Objective 3: … the principal of 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. 27

Objective 3: … the principal of marginal analysis The Rule of Marginal Analysis The optimal quantity is the quantity at which: Marginal Benefit = Marginal Cost Or Marginal Benefit > Marginal Cost 28

Objective 3: … the principal of marginal analysis The Rule of Marginal Analysis The optimal quantity is the quantity at which: Marginal Benefit = Marginal Cost or Marginal Benefit > Marginal Cost Note: Marginal Benefit ≠ Total Benefit (except when going from 0 to 1) 29

Objective 3: … the principal of marginal analysis The Rule of Marginal Analysis The optimal quantity is the quantity at which: Marginal Benefit = Marginal Cost or Marginal Benefit > Marginal Cost Note: Marginal Benefit ≠ Total Benefit (except when going from 0 to 1) Marginal Cost ≠ Total Cost (except when going from 0 to 1) 30

Objective 3: … 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) $ 1 25 2 45 3 60 4 70 5 75 6 79 7 81

Objective 3: … Applying Marginal Analysis Solving the problem Step 1: Determine what is the marginal benefit? The marginal benefit is the marginal revenue or incremental revenue. Hours Open Total Revenue (Total Benefit) $ Marginal Benefit (∆ Total Benefit) 1 25 2 45 20 3 60 15 4 70 10 5 75 6 79 7 81 Now that one colored row should stand out after I say it. Please use a different color for the text in that row, 32

Objective 3: … Applying Marginal Analysis 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. Hours Open Total Revenue (Total Benefit) $ Marginal Benefit (∆ Total Benefit) Cost $0 1 25 10 2 45 20 3 60 15 4 70 5 75 6 79 7 81 Now that one colored row should stand out after I say it. Please use a different color for the text in that row, 33

Objective 3: … Applying Marginal Analysis Net Marginal Benefit/Cost 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. Hours Open Total Revenue (Total Benefit) $ Marginal Benefit (∆ Total Benefit) Cost Net Marginal Benefit/Cost $0 1 25 10 25-10 = 15 2 45 20 20-10= 10 3 60 15 5 4 70 75 –5 6 79 –6 7 81 –7 Now that one colored row should stand out after I say it. Please use a different color for the text in that row,

Objective 3: … Applying Marginal Analysis Net Marginal Benefit/Cost Answer: The optimal number of hours is 4. For the 4th hour, marginal benefit equals marginal cost. Hours Open Total Revenue (Total Benefit) $ Marginal Benefit (∆ Total Benefit) Cost Net Marginal Benefit/Cost 1 25 10 25-10 = 15 2 45 20 20-10= 10 3 60 15 5 4 70 75 –5 6 79 –6 7 81 –7 Now that one colored row should stand out after I say it. Please use a different color for the text in that row,

Objective 3: … Applying Marginal Analysis Example 2: Suppose Dell is currently selling 250,000 Pentium 4 laptops per month. A manager at Dell argues, “The last 10,000 laptops we produced increased our revenues by $8.5 million and our costs by $8.9 million. However, because we are making a substantial profit of $25 million from producing 250,000 laptops, I think we are producing the optimal number of laptops.” Briefly explain whether you agree with the manager’s reasoning. 36

Objective 3: … Applying Marginal Analysis Solving the problem Step 1: Analyze the given information There should be a visual here..two stacks of laptops this visual is in “Module 1 from Steve”. Can you import that visual. Hi Ratha, I see the Modules from Jack and Moon, but I don’t know where Steve’s are. 37

Objective 3: … Applying Marginal Analysis Solving the problem Step 1: Analyze the given information Dell is currently selling 250,000  this is the total output. There should be a visual here..two stacks of laptops this visual is in “Module 1 from Steve”. Can you import that visual. Hi Ratha, I see the Modules from Jack and Moon, but I don’t know where Steve’s are. 250,000 laptops 38

Objective 3: … Applying Marginal Analysis Solving the problem Step 1: Analyze the given information Dell is currently selling 250,000  this is the total output. The last 10,000 laptops  this is the marginal output, i.e. between 240,000 and 250,000 laptops. additional 10,000 Laptops 240,000 laptops 250,000 laptops 39

Objective 3: … Applying Marginal Analysis Step 2: Apply the concepts of marginal analysis Boxed text should transition

Objective 3: … Applying Marginal Analysis Step 2: Apply the concepts of marginal analysis “The last 10,000 laptops we produced increased our revenues by $8.5 million …” What is the another word for the incremental revenue from this last batch of 10,000 laptops and what is the amount of this incremental revenue?  Marginal Revenue or Marginal Benefit = $8.5 million Boxed text should transition

Objective 3: … Applying Marginal Analysis Step 2: Apply the concepts of marginal analysis “The last 10,000 laptops we produced increased … our cost by $8.9 million.” What is the another word for the incremental cost of producing this last batch of 10,000 laptops and what is the amount of this incremental cost?  Marginal Cost = $8.9 million Boxed text should transition

Objective 3: … Applying Marginal Analysis Step 2: Apply the concepts of marginal analysis For the last 10,000 laptops, Marginal Revenue or Marginal Benefit = $8.5 million Marginal Cost = $8.9 million Did the last 10,000 laptops yield a net marginal benefit or a net marginal cost? Net Marginal Cost = $8.5 million - $8.9 million = – $0.4 million Boxed text should transition

Objective 3: … Applying Marginal Analysis Step 2: Apply the concepts of marginal analysis Did the last 10,000 laptops yield a net marginal benefit or a net marginal cost? Another way of putting the question: Did the last 10,000 laptops yield a marginal profit or a marginal loss? Net Marginal Profit/Loss = Marginal Cost – Marginal Revenue = $8.5 million - $8.9 million Net Marginal Loss = – $0.4 million Boxed text should transition

Objective 3: … Applying Marginal Analysis Step 2: Apply the concepts of marginal analysis For the last 10,000 laptops, Marginal Revenue or Marginal Benefit = $8.5 million Marginal Cost = $8.9 million Marginal Profit/Loss = Marginal Benefit–Marginal Cost = –$0.4 million The marginal loss is also called a net marginal cost. Would Dell’s profits be higher if it did not produce the last 10,000 laptops? Yes, since it made a loss on the last 10,000 laptops.  Total Profit from 250,000 laptops = $25.0 million.  Total Profit from 240,000 laptops = $25.4 million Boxed text should transition

Objective 3: … Applying Marginal Analysis Step 3: Draw your conclusion. The manager is failing to think at the margin. Dell has lost $400,000 ($0.4 million) on the last 10,000 laptops. additional 10,000 laptops generated a loss of $0.4 million 240,000 laptops Profit = $25.4 million 250,000 laptops Profit = $25 million

Economic Decision Making and End of Module 1 Economic Decision Making and Marginal Analysis song: Marginal Man album: Identity artists: Marginal Man