### ch4.slides.4e.MEAPSA.ward

```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
• No variation in 1/time.
Econ 5313
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“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.
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
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
• 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
• \$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
• 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?
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
“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
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