Glee Follero, Daryl Gaudiel- Marginal Analysis

INTRODUCTION
Economics may appear to be the study of complicated tables and charts, statistics and numbers, but,
more specifically, it is the study of what constitutes rational human behavior in the endeavor to fulfill
needs and wants.
the study of wealth; and on the other, and more important side, a part of the study of man."

Optimization

An optimization problem involves the specification of three things:
Objective function to be maximized or minimized
Activities or choice variables that determine the value of the objective function
Any constraints that may restrict the values of the choice variables

Maximization problem
An optimization problem that involves maximizing the objective function
Minimization problem
An optimization problem that involves minimizing the objective function

Unconstrained optimization
An optimization problem in which the decision maker can choose the level of activity from an
unrestricted set of values
Ex., profit maximization in the long-run
Constrained optimization
An optimization problem in which the decision maker chooses values for the choice variables from a
restricted set of values
Ex., optimal combination of capital and labor given a cost constraint

Net Benefit
Net Benefit (NB)
Difference between total benefit (TB) and total cost (TC) for the activity
NB = TB TC

Marginal Benefit & Marginal Cost

Marginal benefit (MB)
Change in total benefit (TB) caused by an incremental change in the level of the activity
Marginal cost (MC)
Change in total cost (TC) caused by an incremental change in the level of the activity


MC MB
dx
x dC
dx
x dB
dx
x dC
dx
x dB
dx
x dC
dx
x dB
dx
x dNB
x C x B x NB

: At Max
) (
cost marginal
) (
benefit marginal
) ( ) (
0
) ( ) ( ) (
NB Maximize
) ( ) ( ) (



Optimal Level of Activity


Relating Marginals to Totals

Marginal variables measure rates of change in corresponding total variables
Marginal benefit & marginal cost are also slopes of total benefit & total cost curves, respectively



Using Marginal Analysis to Find Optimal Activity Levels

If marginal benefit > marginal cost
Activity should be increased to reach highest net benefit
If marginal cost > marginal benefit
Activity should be decreased to reach highest net benefit
Optimal level of activity
When no further increases in net benefit are possible
Occurs when MB = MC

Irrelevance of Sunk, Fixed, and Average Costs

Sunk costs
Previously paid & cannot be recovered
Fixed costs
Constant & must be paid no matter the level of activity
Average (or unit) costs
Computed by dividing total cost by the number of units of the activity


Sample Problem: Look for MB and MC.

The Concept of Opportunity Cost

The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the
benefits you could have received by taking an alternative action.
Example 2:
Nantucket Nectars Companys Cost of Making 12-ounce Bottles.

1. Another manufacturer offers to sell Nantucket the bottles for $.18.
2. If the company buys the bottles, $50,000 of fixed overhead would be eliminated.
3. Should Nantucket make or buy the bottles?