Marginal Analysis – Discussion Questions
A.P. Economics
Gary Nelson
Note: We will use these questions in conjunction with our discussion of marginal analysis in chapters 21 & 22 of the
McConnell & Brue text. But these questions are taken from our secondary textbook – Dr. Paul Heyne’s The Economic Way of
Thinking (micro split) which I chose not to issue to you this semester due to our time constraints.
1. In what sense do relative prices reflect relative value? Here is a question to help you think about it. Suppose
that the average wage of a hairdresser is twice the average wage of a child-care worker, and that prompts the
following comment: "By paying hairdressers twice as much as child-care workers, this society is saying that
people who cater to human vanity are twice as valuable as people who care for our children." Is that true in the
situation summarized in Figure 5D? Dhd portrays the demand for hairdressers and Dccw the demand for childcare workers. Shd portrays the supply of qualified hairdressers and Sccw the supply of qualified child-care
workers. The market-clearing wage is $10 for hairdressers and $5 for child-care workers.
(a) In what sense precisely is a hairdresser worth twice as much as a child-care worker in this society?
(b) Since the demand for child-care workers seems to be considerably greater than the demand for
hairdressers, why do hairdressers command twice as high a wage?
(c) Do the supply curves tell us anything about the relative value people place on styling hair versus caring
for children? If the social esteem attached to a particular job increases, what effect will this have on the
supply of qualified people willing to work at that job? What effect will that have in turn on the marketclearing wage rate for the job?
(d) Use the information provided on the graph to make an argument that this society in fact places more
than twice as much value on the services of child-care workers as it places on the services of
hairdressers.
2. Test your understanding of the marginal principle by helping Paul Behrer decide how much fertilizer to apply
to his parsnip patch. We'll keep the problem simple by assuming that, as Paul applies additional fer¬tilizer, the
only cost that changes is the cost of purchasing fertilizer. Here is how yields increase as fertilizer is added:
Bags of Fertilizer Applied
1
2
3
4
5
6
Parsnip Yield in Tons
12
22
28
32
35
37
Paul can sell all the parsnips he raises for $2 a ton. Fertilizer costs $10 per bag, but Paul receives quantity
discounts: 2 bags for $18, 3 for $24, 4 for $30, 5 for $35, and 6 for $42.
(a) What is the marginal benefit to Paul, in dollars, of applying fertilizer? In other words, how many dollars
does Paul add to his receipts from parsnip sales each time he applies an additional bag of fertilizer?
(b) What is the marginal cost of applying additional bags of fertilizer? In other words, by how much do
Paul's costs change each time he adds a bag of fertilizer?
(c) How many bags should Paul apply if he wants to make as much money as possible from parsnip
production?
3. The photocopy machine in the library costs $295 per month to rent. The rental fee covers repair service,
toner, developer, and 20,000 copies per month. The library also pays 1 cent for every copy beyond 20,000, plus
one-half cent for every sheet of paper used.
Harriet Martineau has to read a 20-page journal article for tomorrow’s class. She is willing to pay 50 cents for a
photocopy of the article; but she will read it in the library if she has to pay more than that.
(a) What is the highest price per page Harriet will be willing to pay to use the copier?
(b) What is the lowest price per page the library should be willing to accept? What additional information
must you have in order to answer?
(c) Harriet just found out she is supposed to read a second article for tomorrow's class, an article full of
complex graphs. Harriet badly wants her own copy of this article and will pay whatever she has to pay to
get one. What is now the highest price Harriet will be willing to pay to use the library copier? (You must
supply some information from your own experience to answer.)
(d) How does the $295 monthly rental fee affect the price the library will want to charge users of its copier?
4. In 1981, when AT&T was the exclusive provider of long-distance telephone service in the United States, a
cost specialist for the company estimated the cost of a daytime telephone call from New York to Los Angeles
at 68.9 cents for the initial period and 33 cents for each additional minute. The 68.9 cents included 11.3 cents
for maintenance, 3.3 cents for operator services, 4.4 cents for business services such as sales and advertising,
2.7 cents for pricing and billing, 8.2 cents for depreciation and amortization, 10.6 cents for general purposes,
12.9 cents for taxes, and 15.5 cents for earnings.
(a) When these calculations were made, AT&T was charging less than 25 cents for a one-minute call from
New York to Los Angeles. Was the phone company losing money at that rate? Or don't some of those
costs have to be met at night and on weekends?
(b) AT&T presented these data to the Federal Communications Commission, which oversees long-distance
rates, and asked for permission to set a fee of 74 cents. Does that fact help explain which items the cost
specialist included?
(c) Does it actually cost the phone company less when people place long distance calls at night or on
weekends? What is the marginal cost to the phone company of a call from New York to Los Angeles?
Why might it differ with time of day and day of the week?
(d) An AT&T advertisement in 1989 said: "AT&T's daytime prices are so low, you can call anywhere in the
U.S. for 280 per minute or less." A footnote explained that this was the average price per minute for a
10-minute call, dialed direct. Do you think the cost of providing long distance telephone service fell by
that much in the 1980s?
5. How long will you search for a $20 bill that you lost if you value your time at $5 an hour? Suppose you know
that you lost it somewhere in your bedroom. Would it ever be rational for you to search more than four hours?
Use the concepts of sunk cost and expected marginal cost to explain how a rational person who values time at
$5 an hour could search indefinitely for a lost $20 bill.
\
6. An airline is thinking about adding a daily flight from Denver to Billings. It has estimates of the number of
passengers who would use the flight. What costs should and should not be considered in deciding whether the
anticipated revenue is sufficient to make the flight profitable?
7. The city of Seattle owns a marina and rents space to boat owners. City officials decided in 1981 to set rental
rates that would yield a 5 percent profit on the estimated cost of replacing the facility. They said this would
call for an approximate doubling of moorage fees over the next three years.
(a) What does the estimated cost of replacing the facility have to do with the cost of renting out moorage
space?
(b) The most important part of the facility is the ocean water that fills Puget Sound, on which the marina
was constructed. Should the estimated cost of replacing the ocean be included in the price? (If you argue
that it should not be included because the ocean is a free gift of nature, go back and check your answer
to question.2 at the end of Chapter 3.)
(c) At the time they announced their intention to raise the fees, city officials estimated the waiting time for a
space at 17 to 20 years. What does this have to do with the cost of renting out moorage space?
9. In order to decide whether or not to drop intercollegiate football, your school undertakes a study of the
program's cost. To what extent do you think the following budget items represent genuine costs?
(a)
(b)
(c)
(d)
Tuition scholarships to players.
Payments on the stadium mortgage.
Free tickets to all full-time students.
Salaries of the athletic director, ticket manager, and trainer.
10. What determines the cost to a university of providing parking spaces on campus for faculty, staff, and
students? Why would a parking facility probably cost an urban university more than it would cost a university
located in a small town? If monthly parking fees are higher for students than for faculty, does this mean it costs
the university more to provide parking for students?
12. (a) What differences would you expect to observe in the fees set by three young physicians just setting up
practice if one financed her education by borrowing and must now make payments of $4000 per year for 15
years, another had his entire education paid for by his parents, and the third went all the way through on
government-provided scholarships and grants?
(b) Evaluate the argument, put forward in a Newsweek column of March 19, 1979, that the government could
lower our doctor bills by paying for the entire education of physicians, thus making it unnecessary for
physicians to recover the costs of their education (plus interest) by raising their fees.
(c) The author of the Newsweek article asserts that "you and I" will have to cover the cost of the doctors' loan
repayments in our fees because these payments "are a legitimate cost of doing business." What difference does
it make whether particular payments are or are not "a legitimate cost of doing business"? Suppose all physicians
practicing in an area were required to pay $5000 a year to the local crime syndicate as protection money. Would
these payments be "a legitimate cost of doing business"? Would they affect doctors' fees?
13. In June of 1988, the Canadian Horticultural Council filed a petition with the Canadian Revenue Department
claiming that U.S. apple growers were selling American red and golden delicious apples in Canada at prices
below cost.
(a) U.S. growers admitted that they had sometimes sold below cost, but they blamed this on the huge
harvest. Do you agree that a huge harvest could push prices down below cost? Cost to whom of doing
what?
(b) In response to the petition, the Canadian government sent long questionnaires to U.S. packing houses,
seeking information on the cost of planting new orchards and building new packing plants and coldstorage warehouses. The head of a U.S. apple growers association objected on the grounds that the cost
of orchards and plants many years old is lower than the cost of new ones. Can you resolve this dispute?
14. The Department of Defense awards you a cost-plus-10% contract to build missiles in your garage. Which of
the following may you legitimately include in your costs?
(a) Original cost of constructing the garage, adjusted for inflation and depreciation.
(b) Weather damage to your car from parking it outside because your garage is full of missile-making
machinery.
(c) Cost of lengthening the garage by four feet so the missiles don't extend into your driveway where
neighborhood children might accidentally set one off.
(d) Cost of the course you took at the community college to qualify as a missile maker so you could win the
government contract.
(e) Cost of the math courses you took years ago which turned out to be prerequisites for the course on
missile making.
(f) Cost of your elementary school education, since you wouldn't be able to manufacture missiles if you
didn't know how to read.
(g) Cost of the tetanus shot you received when you were three years old, which saved your life and thereby
enabled you to become a successful defense contractor.
(h) Cost of psychological counseling whereby you seek to overcome depression when your children scorn
you as a member of the military-industrial complex.
15. Backers of the B-2 bomber have argued that it would be wasteful for Congress to stop their manufacture
because so much has already been spent to develop the B-2. Advise Congress on how to deal with this
argument.
17. Should the causalities already incurred in a war be taken into account by a government in deciding whether
it is in the national interest to continue the war? This is obviously not a trivial question. And it is a much more
difficult question than you might at first suppose, especially for a government depending on popular support.
18. What does it cost you to sleep through one of 30 lectures in a course for which you paid $300 in tuition?
19. Do students put more effort into courses when they have to pay higher tuition to take the courses?
20. Do hot dogs taste better at the ball park, where they cost twice as much as they ordinarily cost? Do they
taste better because they cost more?
25. Figure 5F portrays a supply curve of physicians' services and a demand curve for those services. The
market-clearing fee is $30.00.
(a) To what position will the demand curve shift if the government agrees to pay the entire fee charged by
physicians? What will consequently happen to the market-clearing price? (Hint: What quantity will
people demand at a zero price?)
(b) What will happen to the demand curve and to the market-clearing price if the government commits itself
to pay one-half of physicians' fees? (Hint: When the fee charged is $30, what is the fee paid by
consumers? What quantity will they want to purchase at this price?)
(c) What will be the market-clearing price if the government pays 80 percent of the fee charged by
physicians?
26. What is the relationship between costs and prices? The three parts of this question ask you to analyze some
specific cases.
(a) It costs a lot of money to build and equip a halibut fishing boat. Is that why halibut is so expensive to
purchase? What is the relationship between the price of halibut and the cost of a fully equipped halibut
fishing boat?
(b) Do people in poorer neighborhoods pay more for groceries because grocers must charge more to cover
the higher costs associated with higher crime rates? What is the relationship between the price of
groceries and the cost of insurance in high-crime areas?
(c) Does the United States government offer price supports to farmers who grow certain crops because the
cost of growing those crops is high? Or is the cost of growing certain crops high because the government
offers price supports to farmers?
27. You usually pay $1 a bottle to purchase seven bottles of your favorite soda each week. Last Saturday the
store held a special promotion on the occasion of the opening of its new parking lot, and you were able to buy
your weekly supply for just 50 cents a bottle. Your neighbor has just come over to say he ran out of soda during
a party and would like to purchase a couple of bottles if you have any on hand. What would be a fair price to
charge him?
28. The American Economic Review published in its September 1986 issue a fascinating article by Daniel
Kahneman, Jack L. Knetsch, and Richard Thaler that bears on the relevance of costs. It is titled "Fairness as a
Constraint on Profit Seeking: Entitlements in the Market." The authors report on and interpret the results of a
public opinion survey designed to determine the rules of fairness people use in evaluating actions by business
firms.
Here is one hypothetical situation that was described in the survey and the respondents' evaluations:
A grocery store has several months' supply of peanut butter in stock which it has on the shelves and in the
storeroom. The owner hears that the wholesale price of peanut butter has increased and immediately raises the
price on the current stock of peanut butter.
Of the 147 respondents surveyed, only 21% thought this was acceptable behavior while 79% deemed it unfair.
(a) The wholesale price of peanut butter in stock is a sunk cost. Is it relevant to pricing decisions for a seller
who shares the majority view on fairness in pricing?
(b) How could it be relevant to a seller who personally holds the minority view but also knows that his
customers will find out what he has done if he raises the price on "old" stock?
(c) The economist does not distinguish a sum of money paid out from a sum of money not received: both
are equally costs. The majority of the public apparently does distinguish, because it holds that sellers
may raise their prices to cover higher wholesale cost payments but may not do so merely because
consumers are willing to pay the higher prices. Can you defend the popular distinction, or do you think it
is simply the product of failure to understand what's going on?