Marginal Analysis One of economist’s favorite “tricks!”

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Presentation transcript:

Marginal Analysis One of economist’s favorite “tricks!” Take no action unless the expected gain exceeds the expected cost! As long as the extra revenue exceeds the extra cost, do it again!

Suppose the folks listed in the following table are willing to pay the prices shown for a custom yacht. Bill Gates J.C. Penney J. D. Rockefeller J. P. Morgan Paul Allen Create your own table with these prices and the quantity demanded at each price. $13 million $11 million $9 million $7 million $5 million Then make a new column for the total revenue you would get for each pair of price and quantity. Problem modeled after Paul Heyne, The Economic Way of Thinking. Page 213.

Now let’s find marginal revenue. Quantity Demanded 1 (Bill only!) 2 (Bill + JCP?) 3 (now who?) 4 5 Price $13 million $11 million $9 million $7 million $5 million

Change in Total Revenue/Change in Quantity = Marginal Revenue Sell 1, $13 million Second sale adds $9 million (Figure out why?) Third unit adds $5 million And the fourth, $1 million But the fifth, $3 million (red indicates negative) Note that in competitive market each yacht sells for the same price.

Now think about how many you choose to sell Now think about how many you choose to sell. Each yacht costs $6 million. Marginal Revenue $13 million $9 million $5 million $1 million $3 million (red indicates negative) Marginal Cost $6 million

Profit? Go back and look at Marginal Revenue compared to Marginal Cost How many yachts would you choose to sell, assuming you charge each person the same price. Two is the correct answer, and price would be $11 million each!

Price Discrimination? Suppose you could charge each buyer the full price they are willing to pay! Cool! Go back to your table and add a column for the marginal revenue under this new condition.

Marginal Revenue (with P.D.) Yacht 1 Adds $13 million Yacht 2 Adds $11 million Yacht 3 Adds $9 million Yacht 4 Adds $7 million Yacht 5 Adds $5 million How many would you choose to sell now?

FOUR?

And your profit would be …. $16 million! Let’s see now, $16 million profit versus $9 million. Hmmmmmmmmmmm! That’s all folks!