Marginal Cost 1) What are the three rules of profit maximization? 2) Why use Marginal numbers? 3) Do Firms always maximize profits? Examples of Why Marginal Cost is used Why does airline tickets start at a high price, slowly reduce their price, and then have them go back up again right before the flight? What drives private college tuition? What factors do they use to increase attendance and thus revenue? Theory of Consumer Choice Definitions Utility o Amount of satisfaction consumer gets from buying a product. o (Rational) - will spend money to greatest level of satisfaction. Total Utility o Largest sum of money a consumer is willing to spend for a bundle of goods. Marginal Utility o Largest amount of money consumer will give up for ___________ of that good. 1. Derive curve for milk. Family of four, 2 young kids. Each is an INDEPENDENT decision, based on what you previously have. Quantity 0 1 2 3 4 5 6 7 TU $ 0 10 16 20 23 25 26 26.50 MU$ (Do 2nd) - a list we have in our heads, might not know it. 10 6 4 3 2 1 .50 Law of Diminishing Marginal Utility: 3. Derive same chart for blue jeans. Quantity TU $ MU$ 0 0 1 2 3 4 5 6 necessity still necessity still needed don’t need, take if cheap enough use for cat, or extra if cheap give to neighbor give to relatives, birds 4. Where do consumers buy at? What determines how many? Optimal Purchase Rule Buy a good if it’s _______ ________ exceeds it’s price. If the value to you is greater than the price, then buy it. MU>P Benefits > costs John Stossel example buying milk, both parties said: ____________ 5. What is Marginal Utility? The demand curve. o Price low, take a ____ quantity. o Price high, take a _____ quantity. Scenarios: Use the concepts of utility, total utility, and marginal utility to answer the questions. 1. Homer decides it’s time to buy a fishing boat for him and his son Bart to go fishing on weekends. His list of options is below. a. 12’ boat with 4 horse power motor……$1000 b. 12’ boat with 4 horse power motor and reinforced aluminum structure…….$1500 c. 12’ boat with 4 horse power motor, reinforced aluminum structure and a live well for holding lake trout……..$2000 Homer decides to buy option number 2. Explain why he might have made this decision. 2. The Simpsons decide it’s time for a family vacation to England and choose the following vacation plan from a list offered by a travel agency. Round trip airfare, five nights in a 5 star hotel, 2 daily tours and 2 meals per day…….. $4500 After further consideration, the Simpsons switch to another package which includes the following: Round trip airfare, five nights in a 3 star hotel, and 2 dozen donuts per day…………….$5000 Explain why Homer might have made this decision and why Marge might have been upset about it. . 3. “The Freshman 15” – At many colleges, if you live in the dormitory you are required to eat at the school cafeteria. If you live off-campus you do not have to eat at the cafeteria. Studies have shown that students who eat their meals at the cafeteria will gain more weight during their freshman year than those who eat at home. Try to explain why freshman gain weight using the concepts of utility. 4. Vending Machines – To use newspaper vending machines, you put in money, open a door, and take your paper. There is nothing to prevent someone from taking more than one paper, yet this hardly ever happens. Candy machines on the other hand usually have a computerized entry system, and air tight security to prevent people from taking more than they pay for. Why do newspaper machines not have a problem with stealing? Try to explain why news machines do not need more security compared to candy machines.