1. PowerPoint Slides © Michael R. Ward, UTA 2014

2. Donut Holes Making Decisions on the Margin
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.

3. “Nobody can eat fifty eggs”
Econ 5313
“Nobody can eat fifty eggs”
Cool Hand Luke movie clip
Declining marginal value
The marginal value of the 50th egg eaten within an hour is much less than the 1st.

4. Fixed and Variable Costs
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

5. Fixed and Variable Costs
Econ 5313
Fixed and Variable Costs
What are the marginal costs per unit for each of the variable cost items?
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 = $ $ $ $ $0.70 = $2.90/unit

6. Fixed and Variable Costs
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 /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 /unit = $4.15

7. Fixed and Variable Costs
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 5

8. Econ 5313
Problem 4.2f

9. 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 $ 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?
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. 5

10. Extent Decisions If MR exceeds MC, should you sell another unit?
Econ 5313
Extent Decisions
If MR exceeds MC, should you sell another unit?
Always?
If MC exceeds MR, how should you respond?
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. 5

11. 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 5

12. 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? 5

13. 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? 5

14. Comparing Across Alternatives
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. 5

15. Comparing Across Alternatives
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. 5

16. Comparing Across Alternatives
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. 5

17. 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? 5

18. 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. 5

19. The Marginal Voter Marginal Value of a Voter
Econ 5313
The Marginal Voter
Marginal Value of a Voter
Kelsey Grammer pandering for votes in Swing Vote
“Flexible” with positions in order to get 50% + 1
The marginal voter is the most powerful voter
Ex Ohio versus Texas in 2012 election 5

20. From the Blog Chapter 4 Margins in the ACA “High Powered Incentives”
Econ 5313
From the Blog
Chapter 4
Margins in the ACA
“High Powered Incentives”
Sicker Patients
Third-Party Incentives to Cut Medical Costs

21. Main Points AC = TC/Q MC is additional cost for another unit
Econ 5313
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 5