Econ 11 LE 2 PDF - Marginal Analysis

MARGINAL ANALYSIS IN A NUTSHELL (Baumol, ch. 3) 2 THEOREMS 1. Optimal Activity Level. How far should I push for this activity? If the marginal benefit is equal to the marginal cost (zero marginal net yield) that is the time to stop; MAXIMIZE unt...

MARGINAL ANALYSIS IN A NUTSHELL (Baumol, ch. 3) 2 THEOREMS 1. Optimal Activity Level. How far should I push for this activity? If the marginal benefit is equal to the marginal cost (zero marginal net yield) that is the time to stop; MAXIMIZE until marginal net yield reaches zero. 2. Relative Activity Levels. What should I decide between choices? “Activities should be carried to levels where they all yield the same marginal benefit.” Reallocate resources from an activity with small marginal yield to a larger marginal return; Choose the BETTER OPTION in terms of marginal net yield. TOTALS, AVERAGES, AND MARGINALS : ARITHMETIC RELATIONSHIPS 3. First Units. They are all equal As long as all 3 are 0 at the 0th unit, the total, average, and marginal are identical at the first unit If their value is not 0 at the 0th unit, marginal values are still 0 (there is no ‘increase from’ value) 4. Total and Marginal Relationship. Total is always the sum of all the preceding marginals. Ex. 270 is the total at unit 3 with preceding marginals unit 1 = 80, unit 2 = 100, and unit 3 = 90. 5. Relationship between Average and Marginal. For the Average to rise, the Marginal should be above the Average figure and vv. Vv: for average to fall, the marginal should be below the average figure; for it to stay the same, they should be equal. Ex. Marginal Average Marginal Average 1 = 1 3 ⇧ 2 2 ⇧ 1.5 1 ⇩ 1.75 GEOMETRY OF MARGINAL ANALYSIS: TOTAL X CURVES 6. Average X and Total curves. To know the average profit at a point, simply draw a 𝑟𝑖𝑠𝑒 = 𝑦 line that connects it to the origin and find its slope: 𝑟𝑢𝑛 = 𝑥 Looking at Figure 1, simply draw a line from 0 (origin) to A and compute its slope : RA/0R 7. Marginal X and Total curves (?). To know the marginal profit at a point, get the 𝑟𝑖𝑠𝑒 = 𝑦 slope of a tangent line to that point. (still: 𝑟𝑢𝑛 = 𝑥 ) Looking at Figure 1, the slope will be CE/AC MARGINAL AND AVERAGE X CURVES 8. Total x and Average curves: The total cost of any output OQ is the area of the rectangle inscribed under the cost curve which has OQ as its base. Looking at Figure 2, it is the area of rectangle OQ, QR, RS, SO Area: length x width (or OQ x RQ)  9. Total x and Marginal curve. The total cost of producing OQ units of any commodity is that portion of the area under the marginal cost curve which lies above line OQ. Looking at Figure 2, it is the area of OQ that is no longer a rectangle (OQ, QT, TC, CO) Simply get the sum of all the preceding marginals (Rule 4). 10. Straight-line Marginal and Average curves. Deriving marginal from average, always remember Rule # 5 : “for average to ⇧, marginal must be ⇧ and vv.” From the straight line’s end point, extend the line to the vertical axis. Draw any horizontal line from straight-line curve to vertical axis and get the midpoint. Draw a vertical line from the extended point to the horizontal axis, crossing the midpoint. 11. General Marginal and Average curves. Simply draw a tangent line to a given point and apply Rule # 10. Refer to Figure 4. From the straight line’s end point, extend the line to the vertical axis. Draw any horizontal line from straight-line curve to vertical axis and get the midpoint. Draw a vertical line from the extended point to the horizontal axis. Be sure to cross both the midpoint and the line perpendicular to the initial point. Link to the source: https://drive.google.com/file/d/1dRbq1wTyYYhRcUM-tQjbIdygil2wyT13/view?usp=sharing ECONOMICS CHAPTER FIVE Product Markets: Consumer Behavior (Demand Curve) CHOICE AND UTILITY THEORY ★ Utility denotes satisfaction. It is how consumers rank goods and services according to its usefulness to them. ★ Theory of Demand assumes that people always want to maximize their utility, therefore… ★ Consumers ultimately choose whichever gives them the most satisfaction or utility. Marginal Utility ❖ With “marginal” meaning “extra or additional”, marginal utility denotes the additional utility you ➔ Marginal utility is diminishing: get from the consumption of an additional unit of a commodity. Law of Diminishing Marginal Utility ➔ The amount of marginal utility decreases as a person consumes more and more of a good. ➔ For example, eventually, if you eat enough ice cream, instead of adding to your satisfaction or utility, it makes you sick! RS between Total and Marginal Utility Total U is simply the SUM of the Marginal utilities. (Rule # 4) In this case the total utility is 10 units. DEVIATION OF DEMAND CURVES ALTERNATIVE APPROACHES Equimarginal Principle Substitution Effect A consumer will only achieve ➔ When the price of beverage A rises, maximum satisfaction when the MU consumers will tend to substitute it of the last dollar spent on a good is with the cheaper beverage B to exactly the same as the MU of the satisfy their needs with less cost. last dollar spent on any other good, (similar to how businesses behave) therefore, equimarginal. Income Effect 𝑀𝑈 𝑜𝑓 𝑔𝑜𝑜𝑑 𝐴 𝑀𝑈 𝑜𝑓 𝐵 𝑀𝑈 𝑜𝑓 𝐶 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝐴 = 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝐵 = 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝐶 =... ➔ When a price rises and money income is fixed, real income falls If good A costs twice as much as because the consumer cannot afford good B, then buy good B ONLY when to buy the same quantity of goods its MU is twice as great as good B’s. as before. Ex. If good A gives the most MU ➔ Real income - actual quantity of than other goods for a dollar, I goods that your money income can would spend less on other goods to buy. buy more of A. With the law of ➔ Income effect - the change in diminishing MU, if good A’s MU is quantity demanded that arises diminished and becomes equal with because a price change lowers the other goods for a dollar, then I consumers’ real incomes. would stop buying more of it. vv. % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑑 ➔ Income elasticity = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒 Why Does Demand Slope Downward? ★ With increasing price, the MU ratio Substitutes and Complements of a good: 𝑀𝑈 will be less than the Substitutes 𝑝𝑟𝑖𝑐𝑒 ○ Increase of price of A INcreases MU ratio of the other goods, the demand of B. therefore they will decrease their Complement consumption of it. ○ Increase of price of A DEcreases Analytical Developments in U Theory the demand of B. Ordinal - distinguishable and Independent rankable but not measurable; I know ○ Price change of A doesn’t affect A is more than B but I don’t the demand of B. numerically know how much. Cardinal - measurable: Number x is how much A is more than B. FROM INDIV TO MARKET DEMAND THE PARADOX OF VALUE – Market Qd is simply the sum of all of ★ How is it that water, which is the consumers’ Qd. essential to life, has little value, while diamonds, which are generally used for conspicuous consumption, command an exalted price? ★ The more there is of a commodity, the less is the relative desirability of its last little unit. It is therefore clear why water has a low price and why an absolute necessity like air can become a free good. In both cases, it is the large quantities that pull the marginal utilities so far down and thus reduce the prices of these vital commodities. ★ More quantity = less desirability Less desirability = less demand Less demand = lower prices CONSUMER SURPLUS The gap between the ttl. utility (D) of a good and its ttl. market value (P). What consumers would have paid (higher) vs. what they paid (lower) In other words, they got more than what they paid for. The area above the price line, below the demand curve: ○ To get the total consumer surplus, simply add the marginal utilities per unit that is above the price line and below the demand curve. (Rule # 4) ECONOMICS APPENDIX 5: Substitution Ratio: Slope of the IC As one good becomes scarcer, Geometric Analysis of people value each unit of it more Consumer Equilibrium (higher MU), while the good that is THE INDIFFERENCE CURVE more abundant—the “substitute”— ❖ The curve that connects the points becomes relatively less valuable of different consumption bundles or (lower MU). The value of the scarce combinations of commodities which good rises relative to its substitutes. you are indifferent to (both gives the To get the rate of substitution, equal marginal utility), applying the relative to its MU, or substitution Relative Activity Levels Theorem. ratio, simply get its slope: 𝑎𝑚𝑜𝑢𝑛𝑡 𝑔𝑖𝑣𝑒𝑛 𝑢𝑝 (𝑦 𝑟𝑖𝑠𝑒) ❖ Consumption Combinations: 𝑎𝑚𝑜𝑢𝑛𝑡 𝑔𝑎𝑖𝑛𝑒𝑑 (𝑥 𝑟𝑢𝑛) Looking at the given indifference Combo Food Clothing curve from A to B, the consumer A 1 6 gave up 3 units of clothing and gained one unit of food therefore B 2 3 3 having 1 = 3 as the substitution C 3 2 ratio. D 4 1½ Choosing whatever combo (A, B, C, The Indifference Map or D) will give the same MU ❖ Plotted Combinations: An ind. map consists of many indifference curves that represent the best points at which consumers gain the most satisfaction.  Therefore, the higher the EQUILIBRIUM PNT. OF TANGENCY indifference curve is on the map, it Where the budget line intersects is more preferred, i.e. one will get with the highest possible more commodities and more indifference curve will be the satisfaction at U4 than at U3 , U3 equilibrium point at which the than U2 , etc. consumer would consume aiming What constrains consumers from for the highest satisfaction. consuming at the highest ind. curve is their budget. BUDGET LINE At this point we will look at a consumer’s income or “budget”. Example: Budget = $6.00 Clothing = P1 $1.00 / 1 unit Q1 Food = P2 $1.50 / 1 unit Q2 Slope Formula: (B/Py)/(B/Px) Slope: (6/1)/(6/1.5) = 6/4 = 3/2 Checking: Total B = Q1(P1) + Q2(P2) *Plotting one point with regards to the budget, he can buy 6 units of Income Change clothing with 0 units of food: Change in income will shift the 6 ($1.00) + 0 ($1.50) = $6.00 ✔ budget line parallelly: *Plotting another point with regards to the budget, trying buying 3 units of clothing will allow 2 units of food: 3 ($1.00) + 2 ($1.50) = $6.00 ✔ Plotting all the points will result to a straight-sloped budget line: Price Change Total Costs (TC) Change in price of one commodity ➔ Total of fixed and variable costs. will pivot the budget line anchoring ➔ The lowest total expense (FC+VC) to on the commodity that didn’t produce each level of output. change price. ➔ TC rises as output (Q) increases, mostly because of VC. ➔ TC = FC + VC MARGINAL COST (MC) ➔ The additional cost incurred in producing 1 extra unit of output. ➔ Ex. Say a firm is producing 1000 compact discs for a total cost of $10,000. If the total cost of producing 1001 discs costs $10,006, then the MC for the 1001st disc is $6 AVERAGE COSTS: AC, AFC, AVC **Either way: consumers will simply ➔ Applying the Average Rule: jump from one indifference curve to ◆ AC = Total Cost / Q another, trying to gain the highest ◆ AFC = Fixed Cost / Q satisfaction. ◆ AVC = Variable Cost / Q ➔ AFC takes on a downward sloping curve since the FC is getting divided into more Q as more is ECONOMICS CHAPTR SEVEN produced, e.g. from 55/1 = 55 to Analysis of Costs: Consumer 55/5 = 11. ➔ AVC takes on a U-shaped curve FIXED + VARIABLE = TOTAL COST relative to the marginal cost curve. Fixed Costs (FC) Since MC takes on a U-curve, MC ➔ Costs that need to be paid even if either pulls AC up or down as there is no output, e.g. rent for described in Rule #5. The factory, tenured salaries, etc. intersection of AC = MC is the AC’s minimum point from which, after Variable Costs (VC) falling, will start to rise (forming the ➔ Costs that are paid relative to output U-shaped curve). produced, e.g. electricity for factory ➔ AC, being simply the total of AFC operation, steel for automobiles, etc. and AVC, will also take on the U-curve shape relative to AVC. COSTS FORMULA ROUND-UP: When graphed together, the space ➔ FC = given, does not change between AC and AVC is =AFC ➔ VC = given, changes due to ↑ or ↓ of Q (downward sloping) which is why it ➔ TC = FC + VC gets closer and closer but never ➔ MC = ΔTC = e.g. TCQ2 - TCQ1 ; TCQ5 - TCQ4 meets. ➔ AC = (TC/Q) or (AFC + AVC) ➔ AFC = FC/Q ➔ AVC = VC/Q ECONOMICS APPENDIX 7 Analysis of Costs: Production Equal-Product Curve: ISOQUANTS ❖ It can be described as the “indifference curve of suppliers” or the points at which suppliers are maximizing their inputs to produce the most outputs. ❖ Simply trace the similar outputs in the Numerical Production Function, the highlighted 346 and 490, will give us the Equal-Product Curve or Isoquant. Numerical Production Function ❖ Simply get the maximum units one ❖ It is depicts the amount of output can buy at a given price: per input combination: Ex. TC = $6 Land = $3 Labor = $2 Maximizing TC, we can EITHER buy 2 units of Land OR 3 units of Labor. Connecting these 2 points, forming a straight-line, will form your Equal-Cost Curve or Isocost. LEAST-COST TANGENCY ❖ To find out where firms could produce the most at the least cost, ❖ This can also depict the Law of we simply need to marry the Diminishing Marginal Product. As isoquant and the isocost in one more we move further, we can see graph. how the marginal product diminish: Moving → Labor at 1 unit of Land: 2L - 1L = 59 → 3L - 2L = 45 4L - 3L = 37 → 5L - 4L = 34 Equal-Cost Line: ISOCOSTS ❖ It can be described as the “budget line of suppliers” or the points at which suppliers are maximizing their budget to buy each input. ❖ The point of tangency of the least possible isocost with the isoquant determines the least-cost input combination: C ECONOMICS CHAPTR EIGHT SHUTDOWN CONDITIONS Behavior in a Perfectly Short-run 1. If price > shutdown point (AVC), Competitive Market the firm will continue to produce [10/08/24] Dsc. 7: Cost Curves along MC curve since the firm The Demand curve in a Perfectly can still cover the fixed costs. It Competitive Market is a straight line. is more costly to shut down than D, in this sense, is equal to Price, to continue operations. Marginal Revenue, and Average 2. If shutdown point (AVC) > price, Revenue. then the firm will shut down since Firms are price-takers therefore they fixed costs cannot be covered simply conform to the price. No firm anymore. is big enough to affect the price. Profit maximization rule: ○ (D = P = MR = AR) = MC ○ where (D = P = AR = MR) intersects with MC. At M, it is more costly to shut down M’ is the shutdown point. Long-run In the graph, Point A is the profit 1. Firms will continue to operate maximizing point (where MR = MC) only if price > long run AC (given) Also… Since the demand curve is a horizontal line, the Total Market supply is simply (# of firms) x (Q). ECONOMICS CHAPTR NINE FACTOR MARKETS: Behavior in an Imperfectly ECONOMICS CHPTR TWELVE Competitive Market How Markets Detrmine Income The Demand curve in an Imperfectly WEALTH AND INCOME Competitive Market is a downward sloping line. Wealth D, in this sense, is equal to Price, but ★ Consists of the net peso value of not equal to Marginal Revenue, and assets owned by a person at a given Average Revenue. point of time. It is a stock. Firms are price-makers in this sense Income therefore they are the ones that ★ The total receipts or cash earned by decide the price. a person or a household during a The general profit maximization rule given period of time (usually a year). MR = MC can be applied but the TR It consists of labor income, property is where (D = P) = MC, since the firms income, and government transfer control the price, resulting in very payments. It is a flow concept. abundant positive profit. ○ Labor income - wages ○ Property income - rent income ○ Gov’t transfer payments - social security benefits, PhilHealth, etc. Personal incomes vs Factor incomes: ○ Personal - post-tax personal income of an individual consisting of the income of the factors of production that they own. ○ Factor - income of each factor of production (land, labor, capital) National income ○ Consists of labor earnings and In the graph, Point E is the profit property income generated by the maximizing point (where MR = MC) economy in a year. but firms choose to sell at point G ○ Government takes a share of that (where PxQ) having very abundant NI in the form of taxes and gives profit.  back part of what it collects in the ○ 1 worker = $50 form of transfer payments. Maximized profit = $50 wage Perfect Competition Nature of Factor demands ○ Under perfect competition, 1. Derived MRX = Price therefore: When firms demand an input, MRPA = PA = MPA x PX they do so because the input permits PA = wage rate them to produce a good which Imperfect Competition consumers desire now or in the ○ Under imperfect competition future. MRX > Price therefore: 2. Interdependent MRPA = PA = MPA x MRX The productivity of one factor PA = wage rate depends upon the amounts of other factors available to work with. Profit Maximization ★ Add all inputs until it equals MC DISTRIBUTION THEORY Example: ★ The demands for the various factors of production are derived from the revenues that each factor yields on its marginal product. From this point on, A, B, C, shall refer to factors of production [LAND (A), LABOR (L)] while X and Y refer to products… Marginal Revenue Product (MRP) 1 worker = Fixed at $20,000 ★ The MRP of input A is the additional *Hiring 1 worker = $60,000 MRP revenue produced by an additional - $20,000 Cost = $40,000 Profit unit of input A. *Hiring 2nd worker = $30,000 MRP ○ Formula: MRPA = MPA x MRX - $20,000 Cost = + $10,000 Profit ★ The profit-maximizing condition is: *Hiring 3rd worker = $15,000 MRP MRPA = PA (or simply MB = MC) - $20,000 Cost = $5,000 Loss ★ Example: Profit is maximized when MRP = Price. ○ 1 worker = 10 boxes (MPA) If Price > MRP, it will constitute a loss. ○ 10 boxes = $5 (MRX) ○ Therefore, MRPA = PA = $50 In the example, it is best to hire only 2 DETERMINING FACTOR PRICES workers. Less than 2 does not maximize ★ Similar to the previous lessons, it while more than 2 will constitute loss. gets its equilibrium at the intersection of the S and D curves. DEMAND FOR FACTORS ★ The MRP schedule for each input is equivalent to the demand schedule of a firm for that input, therefore… ★ The demand curve for factors of production is also the MRP Curve. ★ Since D = P, then D = P = MRP SUPPLY OF FACTORS ★ DISTRIBUTION OF NAT’L INCOME Neoclassical Theory of Factor-Income Distribution Assumptions: 1. We are only talking about one product, any product, called Q.  2. PQ = 1, so the discussion can be in SUPPLY OF LABOR real terms. This means Q = Q. # of hours the population desires to Under perfect competition: work in gainful activities MRP = MP x P = MP x 1 = MP Elements: Hours worked per worker, In this case, MRP = wage = MP Labor force participation, Immigration To determine how much is allocated to a factor of production, simply plot: Supply Curve of Labor ★ The area of the rectangle 0NES is what goes to labor (wages), the rest is allocated to the other factors (rent). Substitution Effect. Substitutes work ECONOMICS CHAPTER 13 over leisure since work is paying him The Labor Market more (motivation). Rising line (ntural). Income Effect. As wages increase, (Human Capital) the fewer hours they want to work Marginal Productivity of Labor since they can afford expensive Depends on 2 things: leisure (compensation for too much 1. The amount of capital and work). Line bends backwards. technology the worker can work with. LABOR FORCE PARTICIPATION 2. The amount of education and skills Working-age (WAP) - above 15y/o the worker has: more educated = Labor-force (LF) - WAP that are more productive = higher income either employed or looking for work  Labor-force participation (LFPR) - Minimum Wage fraction of WAP in LF: LF/WAP ○ Reduce work hours Employment Rate (ER) - number of ○ Decrease employment probability employed LF / LF ○ Tends to reduce ave. income and Unemployment Rate (UR) - number of raise hh poverty rate LF looking for work / LF Discrimination Underemployment Rate - fraction of ○ Unfair and prejudicial treatment employed that are still looking for of people based on work. characteristice ○ By exclusion: exclusion from good WAGE DIFFERENTIALS jobs from lack daw from evil People are all alike, jobs are alike ○ By “taste”: disc. Against muslims, ○ No wage differential Aetas, etc. People are all alike, jobs differ ○ Statistical Disc.: indivs are treated ○ Compensating wage differential based on their group’s ○ Compensation for unattractive characteristics, not his own. jobs: garbage men > janitor People differ but non-competing ○ Differentials that reflect S and D ECONOMICS CHAPTER 14 for segmented markets ○ Taylor Swift vs You (non-compete) The Land Market People differ, competitive (Natural Resources) ○ General equilibrium pattern of Natural Resource Categories wage differentials determined by Appropriable when firms capture its S and D (can include the prev. 3) full economic value. LABOR ISSUES AND POLICIES Inappropriable when some Trade Unions costs/benefits are associated with ○ Not very strong in the PH its use do not accrue with its owner ○ Bargaining for higher wages Renewable - replenished resources ○ Results to Classical unemployment Non-renewable - cannot be used If wages will be above equilibrium again, supply is fixed it will create a gap / limit on LAND unemployment. Land is the single most valuable ○ Keynesian unemployment: natural resource. naturally occurs in business cycles Its supply curve is completely when there is insufficient demand inelastic (vertical) Prevalent ENDO  Rental - payment for commodities, outcomes because firms will simply like land, that have fixed supply. determine the most profitable pollution levels for them. SUPPLY CURVE OF LAND Ex. They are able to abate 80% of pollution but they would only abate 20% since it is what’s most profitable for them. The government solves this by adding an emissions fee. For firms to have no choice but to reach the gov’t standard. Goods *Public - the community benefits from this positive externality *Private - ones that can be divided and provided separately among individuals *Global Public - benefits are spread across the globe Since supply is fixed, price will depend entirely on the demand and ECONOMICS CHAPTER 15 where it hits the S curve The Capital Market Tax on Land (Produced Capital) Tax in this case is shouldered by the supplier especially if there is no BASIC CONCEPTS change in price. Capital Henry George - just tax the land ➔ Both input and an output; an output that is used as input ENVIRONMENTAL ECONOMICS ➔ Can be tangible or intangible Externalities Rentals *Involuntary cost - negative ➔ Payment for temporary use of *Unprecedented benefit - positive capital goods. Negative Externalities like pollution lead to inefficient economic Financial Assets ➔ Referring to prev. lesson, sacrificing ➔ Pieces of paper deriving their value current consumption to invest will from ownership of assets give way to more future ➔ Monetary claims consumption. Rate of Return on Investment S AND D CURVES OF CAPITAL ➔ Net annual receipts on capital ÷ Demand Curve of Capital Peso value of capital ➔ Like any other factor, the D curve for Interest rate Capital is a derived demand. ➔ Rate of return on financial assets ➔ It comes from the marginal product measured as % per year of capital, which is the extra output yielded by additions to the capital Real Interest Rate stock. ➔ Nominal interest rate - Rate of inflation Supply Curve of Capital (Short-run) Present Value ➔ In the short run, the economy has ➔ The value today of an asset’s stream inherited a given stock of capital of future returns from the past. Therefore the supply ➔ Formula: V = N1/(1+i) + N2/(1+i)2 + curve is vertical. N3/(1+i)3 + N4/(1+i)4 + N5/(1+i)5 + … V = Present Value N = receipts in a period of time i = interest rate in decimals ➔ Present V. for Perpetuities: V = N/i Perpetuity is a type of annuity that lasts forever. The stream of cash flows does not have an end date. THEORY OF CAPITAL, PROFITS, & INTEREST ➔ The price of capital is called interest. ➔ D curve shows the rate of return of Basic Capital Theory capital. ➔ Investment in capital goods involves ➔ From the graph above, the interest foregoing present consumption to rate would be 10%. increase future consumption. The process is a roundabout. PROFITS LAND ➔ Accounting profits are generally larger than economic profits Demand Marginal Product because economic costs are larger Supply Vertical Straight than accounting costs, econ. costs Determining P + Rental including opportunity costs. Pf as Implicit returns ◆ The return to the owners for the LABOR factors of production that they provided in the first place. Demand Marginal Product Pf as reward for risk-bearing Supply Rising; Can bend backwards ◆ The more you risk, the more you gain. But then again, the more you Determining P + Wage risk, the more you can lose as well. Pf as reward for innovation/invention ◆ Profits gained for the CAPITAL advancement of technology. Demand Marginal Product Supply Vertical Straight (short-run) “Price” of Factors Determining P + Interest Rental Land Wage Labor Interest Capital Anything over that Profit