FOCUS: MARGINALFOCUS: MARGINALTHINKINGTHINKING

FOCUS: MARGINALFOCUS: MARGINALTHINKINGTHINKING

You may want to card these terms:You may want to card these terms:economic costeconomic cost marginmarginaccounting costaccounting cost marginalmarginal costcostopportunity costopportunity cost marginal benefitmarginal benefit

explicit/ implicit costsexplicit/ implicit costs utilityutilitytransaction coststransaction costs marginal utilitymarginal utility

search & info costssearch & info costs diminishing marginal utilitydiminishing marginal utility bargaining costsbargaining costs policing & enforcement costspolicing & enforcement costs

Mick just “Can’t get NO SATISFACTION….No UTILITY!”

FOCUS: Marginal Analysis

OBJ.1. Define and explain key terms.2. Apply key concepts.3. Analyze case study. (Widget Works)4. Experience! (Fluffernutter Factory)

How COST-BENEFIT ANALYSIS WORKS!

REVIEW –KINDS OF COSTS:

• Any given activity has 2 distinct kinds of COSTS– ACCOUNTING COST– OPPORTUNITY COST

ACCOUNTING COST:

• A simple MONETARY COST of a good or service $$$$$$$$$$$

• An “OUT-OF-POCKET” expense• An EXPLICIT COST• A DIRECT COST

OPPORTUNITY COST• The value of the next best alternative to any

given activity, good or service• Reflects the nature of a TRADE-OFF. By

choosing to ALLOCATE resources in one way, you decide NOT to use them in any other

• An IMPLICIT COST• An INDIRECT COST

ECONOMIC COST:Accounting Cost+Opportunity Cost TOTAL ECONOMIC COST

Explicit Cost (DIRECT)+Implicit Cost (Indirect) TOTAL ECONOMIC COST

….BUT

Economic exchanges ALSO have other kinds of costs,

like, for instance…

•TRANSACTION COSTS– SEARCH & INFORMATION COST– BARGAINING COST– POLICING & ENFORCEMENT COST

SEARCH & INFORMATION COST:

• Time spent to determine– if desired good is available– best price (comparative shopping)

BARGAINING COST:• Cost of time it takes

– for the parties to come to an acceptable agreement (negotiate a deal)

– to draw up a contract• Lawyer• Notary public• State bureaucracy (permit, license,

corporate charter)

POLICING & ENFORCEMENT COST:

• Time and effort spent to– Ensure that the other party sticks to

the agreed terms– Warranty rights are applied (may

involve lawyer & court costs)

REVIEW: 4 Key Economic Assumptions

• People are RATIONAL.• People are GREEDY (wants =

unlimited).• People act in their own SELF-

INTEREST.• RESOURCES are SCARCE.

COST-BENEFIT ANALYSIS:

• Making a list of the PROS & CONS of a decision

• Weighing the COSTS against the BENEFITS

OPTIMIZATION:

• GOAL– Maximize BENEFIT– Minimize COST

• Requires OPTIMAL (most efficient) ALLOCATION (dividing up for use) of resources

• Examines TRADE-OFFS

THINK ABOUT IT• You are on the city council. Your city needs a

new bridge. Planners say the new bridge will cost $ 1 million, so you budget $1 mil.

• You’ve already spent $1 million, but the bridge isn’t finished. Builders say it will cost another million dollars to finish resulting in a total cost of $2 million

• What should you consider when you decide whether or not to spend another

million bucks to finish the bridge?

Considering theTIME FACTOR!

FOCUS: SUNK COSTS• Incurred in the PAST!• Impossible to recover• Economists don’t consider them

because, “Oh, well…. You can’t get ‘em back, so it’s not RATIONAL!”

UTILITY & SUPPLY and DEMAND:

• DEMAND SIDE – the “buy” side” Law of Diminishing Marginal Utility

• SUPPLY SIDE – the “sell side” Law of Diminishing Marginal

Returns

FOCUS: Utility and the Law of Diminishing Marginal

UtilityOBJ:1. Define key terms.

utility, marginal utility, diminishing marginal utility, “util”

2. Analyze case studies.

TERMS:• Utility: the ability of a good or service to

SATISFY a need/want = satisfaction• Marginal: “one more unit” of something; the

difference between two things• Marginal analysis: what’ll happen if I produce

or consume one more unit• Marginal cost – the cost of producing or

consuming one more • Marginal benefit – the benefit of producing or

consuming one more

THE LAW OF DIMINISHING MARGINAL UTILITY

• UTILITY – the amount of SATIFACTION you get out of consuming another unit of something

• THE LAW OF DIMINISHING MARGINAL UTILITY - each additional unit provides less

• UTILITY or SATISFACTION• “UTILS” : imaginary units used to measure

satisfaction or UTILITY

highlighter

2. Expresso 3. Ice Cream 1. Expresso

#1 #2

#6

#4

#5

#3

9

1

Sunk cost

3

149

11 10 9 8 7 6 5 3 1 -1

140 + 9 =

7 5 2 -2

2-2

FOCUS: EXTERNALITIES• An EXTERNALITY is a COST or a

BENEFIT that affects a third party not involved in a transaction

• TYPES:– POSITIVE (ex.: smelling my neighbor’s

roses)– NEGATIVE (ex.: pollution)

COPY INTO YOUR NOTES NOW !!!!!!