2. 1 Module 1 Economic Decision Making and Marginal Analysis

3. 2 Objectives

4. 3 “either-or” “how much”  To understand and distinguish between the two types of economic decisions: “either-or” decisions and “how much” decisions. Objectives

5. 4 method of economic decision making:  To understand the method of economic decision making: weighing the costs and benefits of any activity before undertaking that activity. Objectives

6. 5 “either-or” “how much”  To understand and distinguish between the two types of economic decisions: “either-or” decisions and “how much” decisions. method of economic decision making:  To understand the method of economic decision making: weighing the costs and benefits of any activity before undertaking that activity. principle of marginal analysis  To understand and apply the principle of marginal analysis used in making “how-much” decisions. Objectives

7. 6 To understand and distinguish between the two types of economic decisions “either-or” decisions and “how much” decisions. Objective 1

8. 7 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.

9. 8 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

10. 9 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.

11. 10 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

12. 11 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.

13. 12 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. “either–or” decision

14. 13 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. “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.

15. 14 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. “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

16. 15 Objective 1: …distinguish between the “either-or” decisions and the “how much” decisions. aThe 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.

17. 16 Objective 1: …distinguish between the “either-or” decisions and the “how much” decisions. aThe 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

18. 17 To understand the method of economic decision making: weighing the costs and benefits of any activity before undertaking that activity. Objective 2 17

19. 18 Objective 2:.. the method of economic decision making  The first step in evaluating an economic activity relevant benefits and costs. is to identify the relevant benefits and costs.

20. 19 Objective 2:.. the method of economic decision making  The first step in evaluating an economic activity relevant benefits and costs. 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 total costs and school, it must first evaluate the total costs and total benefits total benefits of each project and then allocate funds net benefit. to the project that yields the highest net benefit.

21. 20 Objective 2:.. the method of economic decision making  The first step in evaluating an economic activity relevant benefits and costs. is to identify the relevant benefits and costs.  For example, if the state government has to decide total costs andtotal benefits net benefit. 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. either-or decisions,  For either-or decisions, the relevant costs and benefits are the total costs and total benefits.

22. 21 “how-much”  What about the “how-much” decision? Objective 2:.. the method of economic decision making

23. 22 “how-much”  What about the “how-much” decision? marginal or incremental  The relative costs and benefits are the marginal or incremental costs and benefits. Objective 2:.. the method of economic decision making

24. 23 “how-much”  What about the “how-much” decision? marginal or incremental  The relative costs and benefits are the marginal or incremental costs and benefits. principle of marginal analysis  The principle of marginal analysis is used to answer the “how-much” question. Objective 2:.. the method of economic decision making

25. 24 To understand and apply the principle of marginal analysis used in making “how-much” decisions. Objective 3

26. 25 Objective 3:… the principle of marginal analysis “the next step”; incremental step decremental step  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).

27. 26 Marginal Analysis Marginal Analysis involves comparing: Objective 2:.. the method of economic decision making

28. 27 Marginal Analysis Marginal Analysis involves comparing: Marginal Benefit the benefit from the next step which is called Marginal Benefit Objective 2:.. the method of economic decision making

29. 28  Marginal Analysis  Marginal Analysis involves comparing: the benefit from the next step which is called Marginal Benefit with the cost of taking the next step which is called Marginal Cost Objective 2:.. the method of economic decision making marginal cost marginal benefit.  In marginal analysis, the relevant cost is the marginal cost and the relevant benefit is the marginal benefit.

30. 29 If Marginal Benefit > Marginal Cost Net Marginal Benefit  The activity yields a Net Marginal Benefit Objective 2:.. the method of economic decision making

31. 30 If Marginal Benefit > Marginal Cost  Net Marginal Benefit  The activity yields a Net Marginal Benefit If Marginal Benefit < Marginal Cost  Net Marginal Cost  The activity yields a Net Marginal Cost Objective 2:.. the method of economic decision making

32. 31 If Marginal Benefit > Marginal Cost  Net Marginal Benefit.  The activity yields a Net Marginal Benefit. If Marginal Benefit < Marginal Cost  Net Marginal Cost  The activity yields a Net Marginal Cost. If Marginal Benefit = Marginal Cost  optimal  You have reached the optimal quantity. Objective 2:.. the method of economic decision making

33. 32 The Rule of Marginal Analysis The optimal quantity is the quantity at which: Marginal Benefit = Marginal Cost Marginal Benefit > Marginal Cost or Marginal Benefit > Marginal Cost Objective 2:.. the method of economic decision making

34. 33 The Rule of Marginal Analysis The optimal quantity is the quantity at which: Marginal Benefit = Marginal Cost Marginal Benefit > Marginal Cost or Marginal Benefit > Marginal Cost Objective 2:.. the method of economic decision making Note: Marginal Benefit ≠ Total Benefit (except when going from 0 to1)

35. 34 The Rule of Marginal Analysis The optimal quantity is the quantity at which: Marginal Benefit = Marginal Cost Marginal Benefit > Marginal Cost or Marginal Benefit > Marginal Cost Objective 2:.. the method of economic decision making Note: Marginal Benefit ≠ Total Benefit (except when going from 0 to1) Marginal Cost ≠ Total Cost (except when going from 0 to1)

36. 35 Objective 3: ….Applying Marginal Analysis Example 1: 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? HoursOpen Total Revenue (Total Benefit) $ 00 125 245 360 470 575 679 781

37. 36 Hours Open Total Revenue (Total Benefit) $ Marginal Benefit (∆ Total Benefit) $ 000 125 24520 36015 47010 5755 6794 7813 Step 1: Determine what is the marginal benefit? The marginal benefit is the marginal revenue or incremental revenue. Solving the problem

38. 37 Hours Open Total Revenue (Total Benefit) $ Marginal Benefit (∆ Total Benefit) $ Marginal Cost $ 0$0 00 125 10 245 2010 360 1510 470 10 575 510 679 410 781 310 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.

39. 38 Hours Open Total Revenue (Total Benefit) $ Marginal Benefit (∆ Total Benefit) $ Marginal Cost $ Net Marginal Benefit/Cost $ 0$0 00 125 1025-10 = 15 245201020-10= 10 36015105 47010 0 575510–5 679410–6 781310–7 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.

40. 39 Hours Open Total Revenue (Total Benefit) $ Marginal Benefit (∆ Total Benefit) $ Marginal Cost $ Net Marginal Benefit/Cost $ 00000 125 1025-10 = 15 245201020-10= 10 36015105 47010 0 575510–5 679410–6 781310–7 The optimal number of hours is 4. For the 4 th hour, marginal benefit equals marginal cost.

41. 40 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.

42. 41 Solving the problem Step 1: Analyze the given information

43. 42 Solving the problem Step 1: Analyze the given information Dell is currently selling 250,000  this is the total output

44. 43 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

45. 44 Step 2: Apply the concepts of marginal analysis

46. 45 Step 2: Apply the concepts of marginal analysis  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

47. 46 Step 2: Apply the concepts of marginal analysis  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  What is another word for the incremental cost from this last batch of 10,000 laptops and what is the amount of this incremental cost?  Marginal Cost = $8.9 million

48. 47 Step 2: Apply the concepts of marginal analysis  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  What is another word for the incremental cost from this last batch of 10,000 laptops and what is the amount of this incremental cost?  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

49. 48 Step 2: Apply the concepts of marginal analysis  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  What is another word for the incremental cost from this last batch of 10,000 laptops and what is the amount of this incremental cost?  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  Another way of putting the question: Did the last 10,000 laptops yield a marginal profit or a marginal loss?  Marginal Profit/Loss = Marginal benefit – Marginal Cost = – $0.4 million

50. 49 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. The last 10,000 laptops generated a loss. 240,000 laptops total profit = $25.4 million 250,000 laptops total profit = $25 million