PowerPoint Slides © Michael R. Ward, UTA 2014
Econ 5313
Donut Holes
• Making Decisions on the Margin
• A friend does an experiment in class
• Hands one student a box of donut holes. “Eat as many as you
want.”
• Hands another student a watch. “Mark the time between donut
holes.”
• Expect the time between donut holes to increase as more
are eaten
• Graphs 1/time versus quantity – cool!
• Except when he mistakenly gave the box to a football
player. Why was this a problem?
• No variation in 1/time.
Econ 5313
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“Nobody can eat fifty eggs”
Cool Hand Luke movie clip
Declining marginal value
http://www.youtube.com/watch?v=xDWczgxsSaM
The marginal value of the 50th egg eaten within an hour is
much less than the 1st.
Econ 5313
Fixed and Variable Costs
• A factory producing jump drives has rent of $120,000 per
month. Material inputs are $100 for plastic for 1000 units,
connectors at $20 for 100 units, and mini-circuit boards at
$1.30 apiece. Twenty-five workers produce 500 units in an
hour at total compensation of $12/hour. Taxes amount to
$0.70 unit. Management, accounting, and other overhead
come to $80,000 per month.
• Which costs items are variable costs and which are fixed
costs?
• Variable: plastic, connectors, circuits, labor & taxes
• Fixed: rent and overhead
Econ 5313
Fixed and Variable Costs
• What are the marginal costs per unit for each of the
variable cost items?
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Plastic $100/1000 units = $0.10/unit
Connectors $20/100 units = $0.20/unit
Circuit boards $1.30
Labor input 25/500 = 0.05 worker hours per unit. At $12/hour this
is $0.60/unit
• Taxes $0.70/unit
• What are the marginal costs per unit?
• Total MC = $0.10 + $0.20 + $1.30 + $0.60 + $0.70 = $2.90/unit
Econ 5313
Fixed and Variable Costs
• The plant produces 80,000 units per month on average.
• What are average fixed costs?
• Rent: $120,000/80,000 = $1.50/unit
• Overhead: $80,000/80,000 = $1.00/unit
• Total: ($120,000+$80,000)/80,000 = $2.50/unit
• What are the average costs per unit?
• AC = MC + AFC = $2.90/unit + 2.50/unit = $5.40
• Suppose the plant had excess capacity and management
doubled output per month. What are MC, AFC and AC?
• MC unchanged at $2.90/unit
• AFC: ($120,000+$80,000)/160,000 = $1.25/unit
• AC = MC + AFC = $2.90/unit + 1.25/unit = $4.15
Econ 5313
Fixed and Variable Costs
• What does a plot of the MC and AC with output look like?
• MC is constant at $2.90
• AC falls with Q getting closer to MC
Econ 5313
Problem 4.2f
$9.00
$8.00
$7.00
$/unit
$6.00
$5.00
$4.00
MC
$3.00
AC
$2.00
$1.00
$0.00
0
40
80
120
Output
160
200
240
Thousands
Econ 5313
Marginal Revenue
• You are a typical farmer producing cotton for export. The
world price of a pound of cotton for December delivery is
currently $0.7629. What is your marginal revenue per
pound if you sell contracts for 100,000 pounds?
• $0.7629
• What is your marginal revenue per pound if you sell
contracts for 200,000 pounds?
• $0.7629
• In this case, we have that the marginal revenue per pound
is constant. Why would this situation likely have a constant
marginal revenue?
• One typical farmer’s output is not likely to affect price.
Econ 5313
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Extent Decisions
If MR exceeds MC, should you sell another unit?
Always?
If MC exceeds MR, how should you respond?
Always?
• Depends on whether MR and/or MC are rising or falling
• If AC exceeds MR , how should you respond?
• We do not know. MC is relevant not AC.
Econ 5313
Thinking on the Margin
• UT Arlington is experimenting with changing prices tuition
to customers students from a fixed amount per course to
a fixed amount for full-time status regardless of the
number of courses
• How does this affect student behavior?
• Expect your counter-party to think on the margin
Econ 5313
MR and Compensation
• What does the marginal revenue from effort look like for
an hourly sales clerk in the housewares department of
Macy’s?
• What does the marginal revenue from effort look like for a
commission sales clerk in the shoe department of Macy’s?
Econ 5313
Incentive Pay
• Would incentive pay work better for employees selling
tickets at a Cowboy’s stadium box office or employee
lining up group purchases for upcoming events?
• Whose effort is more easily monitored?
Econ 5313
Comparing Across Alternatives
• A mobile telephone company is always looking for new
customers. Their marketing department determines that a
$50,000 increase in the TV ad budget brings in 1,000 new
customers.
• What is the MC for “customer acquisition” from
advertising on TV?
• $50,000 / 1,000 = $50
• Should they increase TV advertising?
• If the marginal revenue generated by this customer is greater
than $50, yes.
• Need to know: expected profits per month, how long they can
expect to keep customer, etc.
Econ 5313
Comparing Across Alternatives
• The mobile telephone company recently cut its telephone
solicitation operations by $10,000 per month and
discovered that their total telephone solicitation yield per
month fell by 100 new customers.
• What is the MC for “customer acquisition” from telephone
solicitations?
• $10,000 / 100 = $100
• Should they increase telephone solicitation operations?
• Need to know if marginal effectiveness from increase is same as
for decrease. (layoff poor workers?)
• If so, increase if the marginal revenue generated by this customer
is greater than $100.
Econ 5313
Comparing Across Alternatives
• Suppose you are responsible for customer acquisition at
the mobile telephone company but you do not know the
marginal revenue generated by a new customer. Your
boss gives you the directive to acquire more customers.
• Do you have enough information to know how you will
spend your budget?
• Yes. MCTV = $50 and MCTel = $100
• TV is cheaper
• Even if you do not know the MR, you can compare MC
across options if you must choose one.
Econ 5313
Where to Downsize?
• Your insurance firm processes claims through its newer,
larger high-tech facility and its older, smaller low-tech
facility.
• Each month, the high-tech facility handles 10,000 claims,
incurs $100,000 in fixed costs and $100,000 in variable
costs.
• Each month, the low-tech facility handles 2,000 claims,
incurs $16,000 in fixed costs and $24,000 in variable costs.
• If you anticipate a decrease in the number of claims,
where will you lay off workers?
Econ 5313
Diamond Wholesaling
• Diamond wholesalers sell finished diamonds to various
merchants every day. A diamond merchant can buy and
sell packets of 200 diamonds of variable quality for
$100,000 for an average wholesale value of $500 each.
• Why don't sellers offer diamonds individually for $500
each?
• Look ahead to the MR and MC to the counter-party and reason
back.
• Some diamonds are worth more than $500 and some less. If sold
individually, the merchant will ‘cherry-pick’ only those with MR >
$500.
Econ 5313
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The Marginal Voter
Marginal Value of a Voter
Kelsey Grammer pandering for votes in Swing Vote
http://www.youtube.com/watch?v=XvLrRC567zQ
“Flexible” with positions in order to get 50% + 1
The marginal voter is the most powerful voter
• Ex Ohio versus Texas in 2012 election
Econ 5313
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From the Blog
Chapter 4
Margins in the ACA
“High Powered Incentives”
Sicker Patients
Third-Party Incentives to Cut Medical Costs
Econ 5313
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Main Points
AC = TC/Q
MC is additional cost for another unit
MR is additional revenue for another unit
Extent decisions compare MR to MC
Expect your counter-party to alter behaviors based on
fixed fees versus fee per unit
• Prime example is incentive compensation