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MARGINAL ANALYSIS



A basic technique used in economics that analyzes small, incremental changes in key variables. Marginal analysis is the primary analytical approached used in the study of markets, production, consumption, business cycles, and economic policies. It not only reflects how most economic decisions are made, it also lends itself to mathematical and graphical analysis.

Marginal analysis is based on a simple question often posed in the study of economics: "What happens if something changes by one dollar, one unit, one person, or one whatever?" For example, what happens to the quantity demanded of hot fudge sundaes if the market price',500,400)">market price increases by one cent? Or what happens to gross domestic product if investment decreases by $1? Or what happens to the market price of computers if one more computer supplier enters the industry?===Marginal Obsession===
The apparent economic obsession with marginal changes exists for at two notable reasons. * Incremental Decisions: One reason is that many economic decisions made in the real world are made "at the margin." Duncan Thurly decides whether or not to eat one more slice of pizza at the all-you-can-eat pizza lunch buffet after having eaten five slices. Winston Smythe Kennsington III decides whether or not to hire an additional worker to the current staff. The Shady Valley City Council debates over adding an extra penny to their existing sales tax. These are marginal decisions, one and all, and just the sort of phenomena investigated with marginal analysis.

  • Sophisticated Analysis: A second reason for using marginal analysis can best be termed analytical sophistication. Economists frequently make use of high-powered mathematical techniques, especially calculus, to create models of markets, consumer behavior, production decisions, or the aggregate economy. Such high-powered mathematical techniques not only lend themselves easily to analyzing incremental changes, but also to building extremely complex models that use these incremental changes to reveal interactions, implications, and conclusions about the economy that are often far from obvious. For example, such a complex model might reveal how a financial crises in Asia affects the construction of new homes in NZ.


Since resources are scarce and we cannot have everything that we want, tough choices must be made. The concept of opportunity cost reminds us that every time we make a choice, something else must be given up. Economics provides us with a set of tools that can help us to make better choices. Often times, the best decision is made by weighing the marginal benefits against the marginal costs.

Definitions:

Utility is the satisfaction derived from the consumption or use of a good or service. Utility is a subjective measure, because one person’s satisfaction may be different from that of another individual. Because satisfaction is difficult to describe in quantifiable terms, we discuss measures of utility in arbitrary units. The term “utils” is often used to describe a unit of utility. This is a bit goofy, so we’ll just use “units of utility” to describe satisfaction. Soon we’ll dispense with the need for arbitrary units by putting utility in dollar terms.

Total Utility (TU) is the total satisfaction or enjoyment realized by a consumer for a given quantity of a good or service. E.g.: if you consume 2 slices of pizza, the total utility is the sum of the satisfaction from both slices.

Marginal Utility (MU) is the additional (extra, incremental) satisfaction realized from the consumption of another unit of the good. E.g.: if you consume a third slice of pizza the marginal utility is the extra utility derived from only the third slice. Hence the marginal utility is the change in total utility for each one-unit change in quantity.

Total Benefit (TB) is the dollar value of the satisfaction realized from the consumption of a given quantity of a good or service. Hence total benefit simply expresses total utility in monetary terms.

Marginal benefit (MB) is the additional dollar benefit from the consumption of an additional unit of a good or service. Hence marginal benefit simply puts marginal utility in monetary terms. Marginal benefit is the change in total benefit for each one unit change in quantity. Marginal benefit also represents the maximum willingness to pay for each unit of a good or service.

Net Benefit (NB) is the difference between marginal benefits and marginal costs. If MB is greater than MC, then net benefits are positive. IF MC is greater than MB, then net benefits are negative.

Utilitarianism

Economic theory is often based upon the philosophy of utilitarianism. The foundation of utilitarian philosophy is "the greatest good for the greatest number." In other words, utilitarian philosophy suggests that decisions be made with the ultimate objective of maximizing societal welfare. Sometimes this choice is easy. For example, when deciding what type of new car to purchase, a consumer should purchase the one that she likes the best given her tastes, so long as it is within her budget. In other words, a consumer can maximize utility by purchasing the things that she likes the best. Other times,the utilitarian principle is not so easy to apply. Should health care be denied to some of our elderly so that the young can have better health care? Should more education funds be devoted to the inner cities at the expense of reducing funds to children in the suburbs? The "greatest good for the greatest number" hinges directly on how we define and quantify "good." To help us answer these types of questions, we need to understand the concepts of marginal costs and marginal benefits.

Marginal Costs

Marginal Costs are the additional costs imposed when one more unit is produced. If the cost of making 9 pieces of pizza is $90 and the cost of making 10 pieces is $110, the marginal cost of producing the tenth piece of pizza is $20. The table below illustrates the relationship between production, total costs,and marginal costs. Notice that total costs always rise as production increases even though marginal costs may not rise.
Quantity
Total Cost
Marginal Cost



































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Marginal costs tend to rise as production increases. One explanation for this is that when a firm grows very large, it becomes more and more difficult to manage the organization and costs rise. Another possibility is that producing more and more of a particular product becomes more difficult due to technology or resource limitations. When trying to clean up the air, for example, the first efforts are relatively inexpensive. A law can mandate, for example, that the dirtiest cars be taken off the road. But as one tries to make the air cleaner and cleaner, more expensive technology is needed. Therefore, marginal costs rise. The rise in Marginal Costs is shown in the chart above.

Marginal Benefits

Marginal Benefits are the additional benefits received when one more unit is produced. Benefits can be expressed in terms of units of utility or satisfaction, or sometimes they can be expressed in dollar amounts.



Economic Efficiency

Economic efficiency in our pizza example occurs where the MB and MC curves intersect. This occurs at a quantity of six pieces of pizza.

In general, the efficient level of output is where the Marginal Benefits just equal the Marginal Costs (point Q*). This is also the level at which the principle of utilitarianism holds. Why is this the case?


If production is less than Q*, for example at QL, then society could benefit overall by producing more. This is because the gains to society (measured by marginal benefits) exceed the costs to society (measured by marginal costs). There will be a net gain to society of the difference between the marginal benefits and the marginal costs.
If production is greater than Q* at QH, then society could benefit by producing less. This is because when we reduce output, the costs imposed on society fall by more than the fall in marginal benefits. Therefore, the greatest good for the greatest number occurs at the intersection of marginal costs and marginal benefits.
Sometimes, the marginal benefits and costs are not "continuous"and we must make decisions about entire projects based upon cost/benefit analysis. Suppose the courts must decide whether or not to allow hundreds of acres of old-growth redwoods to be logged. One could do a cost/benefit analysis to determine what the benefits are to society for harvesting the timber versus the benefits for not harvesting the timber and preserving the forest and the ecosystems. The efficient outcome would be to cut the trees until marginal benefits equal marginal costs. This result may not be possible, however, if an all or nothing decision must be made. The recent compromise in the Headwaters Forest in which most old growth was preserved but other lands and cash were traded in return, certainly did not please either side completely, but perhaps the result was more efficient (but not necessarily more fair) than a solution that allowed the entire area to be harvested, or a decision to ban production completely.
The example over logging demonstrates that the costs and benefits arenot always easily transferable into dollars. This makes the decisions very difficult and inherently more subjective.

The Moral Vacuum of the Efficiency Standard

Cost-Benefit analysis and the efficiency standard are extremely useful tools to approaching complex problems. However, the efficiency standard generally has nothing to say about the morality or fairness of a particular decision. Equity and efficiency are two different things. One must not use the efficiency standard indiscriminately or else he/she arrives at some ridiculus or dangerous conclusions.
For example, suppose the law mandates that the water in a town be cleaned to the point until the marginal costs to society exceed the marginal benefits.At this level, the water is still too dirty to swim in and children who drink from the water are exposed to lead poisoning. Society may decide to clean up the water even more than the efficient level because we do not want to harm children. Even though the solution may not be efficient, it may be more fair.
In health care, the efficient outcome may be to only provide health services to those to whom the benefits from being made healthier exceed the costs of the health care. Therefore, elderly citizens may not get the treatment they require because society sees few benefits in terms of life extension. Again, the efficient outcome is not always the fair outcome and society may decide that it is more equitable to provide quality health care to the elderly.
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Marginal utility


In economics, the marginal utility of a good or service--or, alternatively, the marginal utility of the active consumption of a good or service (see Hermann Heinrich Gossen)-- is the utility gained (or lost) from an increase (or decrease) in the consumption of that good or service. In general, preferences display diminishing marginal utility. That is, the first unit of consumption of a good or service yields more utility than the second and subsequent units. The concept of marginal utility played a crucial role in the marginal revolution of the late 19th century, and led to the replacement of the labor theory of value by neoclassical value theory in which the relative prices of goods and services are simultaneously determined by marginal rates of substitution in consumption and marginal rates of transformation in production, which are equal in economic equilibrium.

Marginality

Constraints are conceptualized as a border or margin.[1] The location of the margin for any individual corresponds to his or her endowment, broadly conceived to include opportunities. This endowment is determined by many things including physical laws (which constrain how forms of energy and matter may be transformed), accidents of nature (which determine the presence of natural resources), and the outcomes of past decisions made both by others and by the individual himself or herself.
For reasons of tractability, it is often assumed in neoclassical analysis that goods and services are continuously divisible. Under this assumption, marginal concepts, including marginal utility may be expressed in terms of differential calculus. Marginal utility can be defined as a measure of relative satisfaction gained or lost from an increase or decrease in the consumption of that good or service.
However, strictly speaking, the smallest relevant division may be quite large. Frequently, economic analysis concerns the marginal values associated with a change of one unit of a discrete good or service, such as a motor vehicle or a haircut.


Diminishing marginal utility

What Does Law Of Diminishing Marginal Utility Mean?
A law of economics stating that as a person increases consumption of a product - while keeping consumption of other products constant - there is a decline in the marginal utility that person derives from consuming each additional unit of that product.
This is the premise on which buffet-style restaurants operate. They entice you with "all you can eat," all the while knowing each additional plate of food provides less utility than the one before. And despite their enticement, most people will eat only until the utility they derive from additional food is slightly lower than the original.

For example, say you go to a buffet and the first plate of food you eat is very good. On a scale of ten you would give it a ten. Now your hunger has been somewhat tamed, but you get another full plate of food. Since you're not as hungry, your enjoyment rates at a seven at best. Most people would stop before their utility drops even more, but say you go back to eat a third full plate of food and your utility drops even more to a three. If you kept eating, you would eventually reach a point at which your eating makes you sick, providing dissatisfaction, or 'dis-utility'.
The fact that a tipping point may be reached does not imply that marginal utility will continue to increase indefinitely thereafter. For example, beyond some point, further doses of antibiotics would kill no pathogens at all, and might even become harmful to the body. Simply put, as the rate of commodity consumption increases, marginal utility decreases. If commodity consumption continues to rise, marginal utility at some point falls to zero, reaching maximum total utility. Further increase in consumption of units of commodities causes marginal utility to become negative; this signifies dissatisfaction.

Marginal and Total Utility

Marginal utility measures the extra utility (or satisfaction) from consuming an additional unit of a product. Total utility is the total satisfaction from the consumption of a product. If, for example, the extra utility from consuming another unit of the product is 6 units of utility (called utils) then total utility will increase by 6 utils.


















total utility increases at a diminishing rate. When marginal utility is 0 this means there is no increase in total satisfaction from the consumption of that unit (in this case the 6th unit). It is possible that you can overconsume some items (e.g. eat too much) in which case the marginal utility might be negative (the 7th unit) and total utility would then fall.

The paradox of value: marginal and total utility

Some products are widely available and are heavily consumed. This means that the extra utility from consuming one more unit is low as is the price we are willing to pay for that unit. Even though the product may be vitally important such as bread in the UK the fact it is widely available reduces the value of an additional unit. Other products, such as Ferarris, are not widely available and have limited consumption. This means the marginal utility of an extra unit is high and therefore we are willing to pay a high price for it. Even though bread is more important in terms of our survival and provides more total utility we are not willing to pay as much for it as Ferarris because of its low marginal utility. This is known as the paradox of value.
Interestingly the typical example of the paradox of value is water and diamonds first outlined by Adam Smith in 1776.
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When TU is maximised MU will be equal to zero

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practice test link:

http://wps.prenhall.com/bp_ayers_micro_1/0,,487079-,00.utf8.html


MARGINAL UTILITY AND DEMAND:

An explanation of the law of demand and the negatively-sloped demand curve based on utility analysis and the law of diminishing marginal utility. The law of diminishing marginal utility states that marginal utility declines as consumption increases. Because demand price depends on the marginal utility obtained from a good, price also declines as consumption increases, meaning price and quantity demanded are inversely related, which is the law of demand.
Marginal utility and the law of diminishing marginal utility can be used to provide insight into market demand, the law of demand, and the demand curve. This insight rests on two propositions.

  • One, the law of diminishing marginal utility means that the marginal utility obtained from consuming a good declines as the quantity consumed increases.

  • Two, the marginal utility of a good underlies the demand price that buyers are willing and able to pay for a good.
When combined, these two propositions indicate the demand price that buyers are willing and able to pay for a good declines as the quantity demanded (and consumed) increases, which is the law of demand.

Starting with Utility

Edgar Rides the Coaster

Sundae Utility
Sundae Utility

Sundae Utility

The graph displayed at the right is Edgar Millbottom's marginal utility curve for riding the Monster Loop Death Plunge roller coaster during a day at the Shady Valley Amusement Park. By transforming this curve ever so slightly, Edgar's demand curve for roller coaster rides can be derived.
But first, consider the marginal utility curve itself.


  • The marginal utility curve has a negative slope, illustrating the law of diminishing marginal utility.

  • Marginal utility curve intersects the horizontal axis at 6 rides. Marginal utility is positive up to that point, then becomes negative after.
The task at hand is to transform this marginal utility curve into a demand curve. To do this, though, a little more information is needed.

Adjusting the Rule

According to the rule of consumer equilibrium, people like Edgar buy goods such that the marginal utility-price ratio for each good is equal, satisfying this equation:



marginal utility of good 1----
price of good 1
=
marginal utility of good 2----
price of good 2

However, in the derivation of Edgar's demand curve for roller coaster rides, the key comparison is not between roller coaster rides and ONE other good, but with ALL other alternatives. The big assumption, therefore, is that Edgar achieves consumer equilibrium and satisfies this rule of consumer equilibrium for ALL other goods.
If so, then Edgar has a "standard" or "benchmark" marginal utility-price ratio. For the sake of exposition, suppose that Edgar's benchmark marginal utility-price ratio is 2 utils per dollar. In other words, Edgar purchases all sorts of different goods such that the last dollar spent on each good generates 2 utils of satisfaction.
It this case, it is possible to specify the rule of consumer equilibrium as:

marginal utility of roller coaster rides----
price of roller coaster rides
=
marginal utility of all other goods----
price of all other goods
= 2 utils per dollar

If this equation is rearranged just a little, the result is:

marginal utility of roller coaster rides----
2 utils per dollar
=
price of roller coaster rides

The beauty of this equation is that the price that Edgar is willing and able to pay for roller coaster rides (his demand price) is now connected to the marginal utility derived from those rides.

Making the Conversion

The Conversion

Utility to Demand
Utility to Demand

Utility to Demand

In terms of the original marginal utility graph, dividing the marginal utility on the vertical axis by 2 utils per dollar transforms the marginal utility curve into a demand curve. Click the [Demand Curve] button to make this happen.
Not much changes upon clicking the [Demand Curve] button. One change is the measurement units on the vertical axis from utils to dollars. The other change is the elimination of that part of the curve in the negative range of marginal utility and price (negative prices are not relevant). Feel fee to click the [Reset] and [Demand Curve] buttons a couple of times to confirm that not much changes.
Multiple button clicks should serve to emphasize that the marginal utility curve and the demand curve are closely related, that demand is based on marginal utility, and that the law of diminishing marginal utility is the foundation for the law of demand.


The Optimal Purchase Rule
For each good
($)Price=($)Marginal utility
As long as the $ price of ice cream is lower than the ($) marginal utility of ice cream, Jill keeps increasing her purchase of ice cream.
In other words, as long as the marginal net utility of ice cream is positive, Jill keeps buying ice cream.
Marginal net utility = ($)MU- $P> 0
The Two-Good Rule
($)MUa ($)MUb
--------- = ----------
$Pa $Pb
MUa= marginal utility of ice cream
MUb= marginal utility of hamburger
Pa= price of ice cream
Pb= price of hamburger

good link
http://www.info-village.info/law-of-equi-marginal-utility/

The utility-maximizing rule (also known as the “equimarginal principle”) states that total utility from the consumption of two or more goods is maximized when the marginal utility per dollar spent is the same for all goods, and all income is spent.


http://ingrimayne.com/econ/LogicOfChoice/Equimarginal.html

http://zulunotes.com/wiki/index.php/Equi-marginal_principal

Consumer Equilibrium

When consumers make choices about the quantity of goods and services to consume, it is presumed that their objective is to maximize total utility. In maximizing total utility, the consumer faces a number of constraints, the most important of which are the consumer's income and the prices of the goods and services that the consumer wishes to consume. The consumer's effort to maximize total utility, subject to these constraints, is referred to as the consumer's problem. The solution to the consumer's problem, which entails decisions about how much the consumer will consume of a number of goods and services, is referred to as consumer equilibrium.

Determination of consumer equilibrium. Consider the simple case of a consumer who cares about consuming only two goods: good 1 and good 2. This consumer knows the prices of goods 1 and 2 and has a fixed income or budget that can be used to purchase quantities of goods 1 and 2. The consumer will purchase quantities of goods 1 and 2 so as to completely exhaust the budget for such purchases. The actual quantities purchased of each good are determined by the condition for consumer equilibrium, which is


external image 9675.nce001.jpg
external image 9675.nce001.jpg




This condition states that the marginal utility per dollar spent on good 1 must equal the marginal utility per dollar spent on good 2. If, for example, the marginal utility per dollar spent on good 1 were higher than the marginal utility per dollar spent on good 2, then it would make sense for the consumer to purchase more of good 1 rather than purchasing any more of good 2. After purchasing more and more of good 1, the marginal utility of good 1 will eventually fall due to the law of diminishing marginal utility, so that the marginal utility per dollar spent on good 1 will eventually equal that of good 2. Of course, the amount purchased of goods 1 and 2 cannot be limitless and will depend not only on the marginal utilities per dollar spent, but also on the consumer's budget.
An example. To illustrate how the consumer equilibrium condition determines the quantity of goods 1 and 2 that the consumer demands, suppose that the price of good 1 is $2 per unit and the price of good 2 is $1 per unit. Suppose also that the consumer has a budget of $5. The marginal utility ( MU) that the consumer receives from consuming 1 to 4 units of goods 1 and 2 is reported in Table 1 . Here, marginal utility is measured in fictional units called utils, which serve to quantify the consumer's additional utility or satisfaction from consuming different quantities of goods 1 and 2. The larger the number of utils, the greater is the consumer's marginal utility from consuming that unit of the good. Table 1 also reports the ratio of the consumer's marginal utility to the price of each good. For example, the consumer receives 24 utils from consuming the first unit of good 1, and the price of good 1 is $2. Hence, the ratio of the marginal utility of the first unit of good 1 to the price of good 1 is 12.




Units of good 1
MU of good 1
MU/price of good 1
Units of good 2
MU of good 2
MU/price of good 2









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Read more: http://www.cliffsnotes.com/study_guide/Consumer-Equilibrium.topicArticleId-9789,articleId-9753.html#ixzz0uf6PhrC4


Read more: http://www.cliffsnotes.com/study_guide/Consumer-Equilibrium.topicArticleId-9789,articleId-9753.html#ixzz0uf6GuPo8


power point on deriving the demand curve from MU:

external image vnd.ms-powerpoint.png mu& demandcurve.ppt

Accounting Costs vs Opportunity Costs


Opportunity cost is the cost related to the next-best choice available to someone who has picked between several mutually exclusive choices. It is a key concept in economics. It has been described as expressing "the basic relationship between scarcity and choice." The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs.
The concept of an opportunity cost was first developed by John Stuart Mill.

Examples

  • A person who has $15 can either buy a CD or a shirt. If he buys the shirt the opportunity cost is the CD and if he buys the CD the opportunity cost is the shirt. If there are more choices than two, the opportunity cost is still only one item, never all of them.
  • A person who invests $10,000 in a stock denies herself or himself the interest that could have accrued by leaving the $10,000 in a bank account instead. The opportunity cost of the decision to invest in stock is the value of the interest.
  • A person who sells stock for $10,000 denies himself or herself the opportunity to sell the stock for a higher price (say $12,000) in the future, inheriting an opportunity cost equal to the future price of $12,000 (and not the future price minus the sale price). Note that in this case, the opportunity cost can only be determined in hindsight.
  • A person who decides to quit their job and go back to school to increase their future earning potential has an opportunity cost equal to their lost wages for the period of time they are in school. Conversely, if they elect to remain employed and not return to school then the opportunity cost of that action is the lost potential wage increase.
  • An organization that invests $1 million in acquiring a new asset instead of spending that money on maintaining its existing asset portfolio incurs the increased risk of failure of its existing assets. The opportunity cost of the decision to acquire a new asset is the financial security that comes from the organization's spending the money on maintaining its existing asset portfolio.
  • If a city decides to build a hospital on vacant land it owns, the opportunity cost is the value of the benefits forgone of the next best thing that might have been done with the land and construction funds instead. In building the hospital, the city has forgone the opportunity to build a sports center on that land, or a parking lot, or the ability to sell the land to reduce the city's debt, since those uses tend to be mutually exclusive. Also included in the opportunity cost would be what investments or purchases the private sector would have voluntarily made if it had not been taxed to build the hospital. The total opportunity costs of such an action can never be known with certainty, and are sometimes called "hidden costs" or "hidden losses" as what has been prevented from being produced cannot be seen or known. Even the possibility of inaction is a lost opportunity. In this example, to preserve the scenery as-is for neighboring areas, perhaps including areas that it itself owns.

Opportunity cost is assessed in not only monetary or material terms, but also in terms of anything which is of value. For example, a person who desires to watch each of two television programs being broadcast simultaneously, and does not have the means to make a recording of one, can watch only one of the desired programs. Therefore, the opportunity cost of watching Dallas could be enjoying Dynasty. Of course, if an individual records one program while watching the other, the opportunity cost will be the time that that individual spends watching one program versus the other. In a restaurant situation, the opportunity cost of eating steak could be trying the salmon. For the diner, the opportunity cost of ordering both meals could be twofold - the extra $20 to buy the second meal, and his reputation with his peers, as he may be thought gluttonous or extravagant for ordering two meals. A family might decide to use a short period of vacation time to visit Disneyland rather than doing household improvements. The opportunity cost of having happier children could therefore be a remodeled bathroom.

Evaluation

The consideration of opportunity costs is one of the key differences between the concepts of economic cost and accounting cost. Assessing opportunity costs is fundamental to assessing the true cost of any course of action. In the case where there is no explicit accounting or monetary cost (price) attached to a course of action, or the explicit accounting or monetary cost is low, then, ignoring opportunity costs may produce the illusion that its benefits cost nothing at all. The unseen opportunity costs then become the implicit hidden costs of that course of action.
Note that opportunity cost is not the sum of the available alternatives when those alternatives are, in turn, mutually exclusive to each other. The opportunity cost of the city's decision to build the hospital on its vacant land is the loss of the land for a sporting center, or the inability to use the land for a parking lot, or the money which could have been made from selling the land, as use for any one of those purposes would preclude the possibility to implement any of the others.
However, most opportunities are difficult to compare. Opportunity cost has been seen as the foundation of the marginal theory of value as well as the theory of time and money.
In some cases it may be possible to have more of everything by making different choices; for instance, when an economy is within its production possibility frontier. In microeconomic models this is unusual, because individuals are assumed to maximise utility, but it is a feature of Keynesian macroeconomics. In these circumstances opportunity cost is a less useful concept.


What Does Economic Profit (Or Loss) Mean?
The difference between the revenue received from the sale of an output and the opportunity cost of the inputs used. This can be used as another name for "economic value added" (EVA).
Economic Profit (Or Loss)
Don't confuse this with 'accounting profit', which is what most people generally mean when they refer to profit.

In calculating economic profit, opportunity costs are deducted from revenues earned. Opportunity costs are the alternative returns foregone by using the chosen inputs. As a result, you can have a significant accounting profit with little to no economic profit.

For example, say you invest $100,000 to start a business, and in that year you earn $120,000 in profits. Your accounting profit would be $20,000. However, say that same year you could have earned an income of $45,000 had you been employed. Therefore, you have an economic loss of $25,000 (120,000 - 100,000 - 45,000
external image marketstructuremap.gif
external image marketstructuremap.gif

Market Structures - Mind Map

Mind Maps have been produced to introduce topics and give students an overview of key topics being studied. The maps can be viewed as a whole page or, for those who prefer a more linear approach, as a text version.
  • Perfect Competition
    • Many Buyers and Sellers
    • Freedom of entry and exit
    • Homogenous products
    • Perfect information
    • Sellers - price takers
    • Long run normal profit
  • Imperfect/Monopolistic Competition
    • Many Buyers and Sellers
    • Differentiated products
    • Relatively free entry and exit
    • Some control over price
    • Tiny monopoly over product
  • Oligopoly
    • Competition amongst the few
    • Concentration ratio
    • High Barriers to entry
    • Non-Price competition
    • Price stability?
    • Kinked Demand Curve
    • Product differentation
    • Collusion?
    • Abnormal Profits
    • Interdependence between firms
  • Monopoly
    • Firm = Industry
    • Natural Monopolies
    • 25%+ Market Share
    • Control over price OR output
    • Price discrimination?
    • High Barriers to Entry
    • Consumer choice
    • Abnormal Profits

Price and non price competition


benefits of competitive markets

Why are competitive markets seen as beneficial for consumers and the economy as a whole?

"Vigorous competition between firms is the lifeblood of strong and effective markets. Competition helps consumers get a good deal. It encourages firms to innovate by reducing slack, putting downward pressure on costs and providing incentives for the efficient organisation of production. As such, competition is a central driver for productivity growth in the economy.
Competitive markets exist when there is genuine choice for consumers in terms of who supplies the goods and services they demand. Competitive markets are characterised by various forms of price and non-price competition between sellers who are bidding to increase or protect their market share.

What are the potential gains from increased market competition?
  1. Lower prices for consumers
  2. A greater discipline on producers/suppliers to keep their costs down
  3. Improvements in technology – with positive effects on production methods and costs
  4. A greater variety of products (giving more choice)
  5. A faster pace of invention and innovation
  6. Improvements to the quality of service for consumers
  7. Better information for consumers allowing people to make more informed choices
The overall impact of increased competition should be an improvement in economic welfare.

Price and Non Price Competition
Firms compete for market share and the demand from consumers in lots of ways. We make an important distinction between price competition and non-price competition.

Price competition can involve discounting the price of a product to increase demand.



Consider the example of the supermarket sector where non-price competition has become important in the battle for sales

  • Traditional advertising / marketing
  • Store Loyalty cards
  • Banking and other Services (including travel insurance)
  • In-store chemists and post offices
  • Home delivery systems
  • Discounted petrol at hypermarkets
  • Extension of opening hours (24 hour shopping)
  • Innovative use of technology for shoppers including self-scanning and internet shopping services

Price and Non Price Competition


Price competition

Strategy used to increase sales and market share, by undercutting competitors.

Where a company tries to distinguish its product or service from competing products on the basis of low price.

Match, beat the price of the competition. To compete effectively, need to be the lowest cost producer.
Must be willing and able to change the price frequently. Need to respond quickly and aggressively.
Competitors can also respond quickly to your initiatives.
Customers adopt brand switching to use the lowest priced brand.
Sellers move along the demand curve by raising and lowering prices.
Demand Curve






Key concepts: loss leader, price war

Non Price competition

Non-price competition is a marketing strategy "in which one firm tries to distinguish its product or service from competing products on the basis of attributes like design and workmanship" (McConnell-Brue, 2002, p. 437-438).

Emphasis on product features, service, quality etc. Can build customer loyalty towards the brand. Must be able to distinguish brand through unique product features.
Customer must be able to perceive the differences in brands and view them as desirable.
Should be difficult (impossible) for competitors to emulate the differences (PATENTS)
Must promote the distinguishing features to create customer awareness.
Price differences must be offset by the perceived benefits.
Sellers shift the demand curve out to the right by stressing distinctive attributes (consumers must perceive and desire particular attributes).



Product differentiation

Products are marketed to appear to have differences, like superior qualities to competitor’s products.

Advertising

Common method used to stimulate/ create demand for a product through print, TV, radio, posters, billboards and the internet. A latest craze is viral marketing.

Remember:

The "teenager" who claimed to be selling naked photos of his mother on Trade Me has been exposed as a liar who ran the auction for a design school project.

Product placement is also common where products are part of a TV show or movie and are endorsed by celebrities, sexualisation, fun or discrediting a competition



Celebrity Endorsement
tiger woods and gillette


Branding
nike tick


Packaging
fancy vs budget



Location


Sponsorship
foot traffic


Loyalty schemes
coffee card


Service: by offering special services, businesses hope to influence your future buying.




Product Variation: businesses use REAL variation in their products to make them different and superior to competition.

The two main types are product modification and vertical product variation.





Product modification

Other examples include airbags, stability control, GPS in cars etc.


Vertical product variation

When a business makes their product appeal to a wider range of income levels by introducing a number of different models of the same product

e.g.
Car manufacturers may have an economy model through to a sports model. They use things like engine size, mag wheels, tints and paint jobs


Advantages and Disadvantages of non price competition for consumers and producers

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Advantages
Disadvantages
Producers
· Will increase sales, shifting supply curve right
· Greater market power to increase market share.
· Will not have to cut prices to increase market share
· Higher costs as a result of advertising, so low profitability
· With vertical product variation, fewer of each model is produced, can be at a disadvantage when competing with a firm that makes only 1 model
· Increase in average costs
Consumers
· Possible increase in choice with extra brands, where the difference is perceived only
· Improved quality of good or service
· Prizes and sponsorship
· Prices overall may increase to pay for free offers, etc for both types.
· May still receive an average product at an inflated price

Opening Up Markets - Liberalisation
Creating more competition in markets involves breaking down the barriers to competition that invariably exist in each industry. Perfectly contestable markets are rare. One of the key strategies of governments over the last twenty years has been to liberalise markets by cutting the statutory monopoly power of businesses. Two good examples of this have been in gas and electricity supply, and also telecommunications.
Energy market liberalisation
Liberalisation of energy markets has led to lower costs through increased efficiency and lower prices for consumers. The UK gas and electricity markets are already fully liberalised, with all types of customer able to choose their own supplier. For example: More than 30% of domestic gas customers and 25% of electricity customers have switched suppliers and domestic electricity prices have fallen as markets have opened up.

Opening Up Markets (2) - Tougher Regulation
Privatisation and liberalisation of markets has opened many sectors to greater competition. A second strand to current government policy is to toughen up the regulation of markets through competition policy.

profit and sales revenue maximisation using total cost and total revenue curves

Introduction
One way of showing the differences in output that can come from different business objectives is to use total revenue and total cost curves. If we assume that a business faces a downward sloping demand curve, the total revenue curve will rise at a decreasing rate until marginal revenue = zero. The shape of the total cost curve depends on what happens to marginal cost, if we assume that diminishing returns occurs in the short run, then the total cost will eventually start to rise at an increasing rate. The profit maximising output occurs at the greatest vertical distance between the TR and TC curves. However, revenue maximization occurs at a higher output level.
external image objectives_1.gif
external image objectives_1.gif


Shareholders might decide that a minimum level of profitability is required – so we might include in our analysis the effect of such a constraint on the output choice. This is shown in the diagram below
external image objectives_2.gif
external image objectives_2.gif



An alternative way of showing the differences in price and output that come from varying the objectives of the firm is by using average and marginal revenue curves together with average and marginal cost curves. These are shown in the diagram below. The profit maximising output (where MC=MR) is Q1 which can be sold at a price P1, whereas a firm seeking to maximise revenue will produce at output Q2 (where MR = zero) which requires a lower market price. You can then work with the average total cost curve to show the different levels of profit that will exist at each price and output combination.


external image objectives_3.gif
external image objectives_3.gif




Ownership and Control
Any corporation is an organization with various groups
Employees
Managers
Shareholders
Customers
The dominant group at any moment in time can give greater emphasis to their own objectives. In corporations where there is a clear divorce between ownership and control, the managers within a business may use their discretionary powers in deciding on price and output in different segments of markets over which they have some control to meet their own objectives.

Satisficing Behaviour
Maximising behaviour may be replaced by satisficing – a process which involves setting minimum acceptable levels of achievement (such as a minimum acceptable rate of return on capital). The Equity and Bond markets may play an important role in monitoring the performance of managers in a company. Companies that under perform in the longer term will find their share price coming under selling pressure and as the market value of a quoted company declines, so the business becomes ripe for a hostile takeover. The stock market is not a perfectly efficient judge of company performance relative to others in specific industries, but overall, the market for “corporate control” does exercise some constraint on the management decisions of listed companies

Profit Maximisation in the Long Run
Plenty of businesses depart from pure profit maximisation in the short run in order to achieve alternative objectives. Indeed the highly cyclical nature of many industries and the lack of full and accurate information on costs and demand make this virtually inevitable. There are plenty of good reasons for believing that revenue maximisation is a legitimate and realistic objective for businesses in the short to medium term, perhaps with the constraint of a satisfactory rate of profit at the same time. In the long run though, the desire to reach a high commercial rate of return becomes more important. Companies may choose to depart from the textbook assumption of profit max for particular periods, but return to it over a longer time horizon.

Goals other than profit maximisation can be:
>environmental
>socially responsible
>pride in quality
>pride in lowest price
>market share/ sales maximisation

Business Revenues


income that businesses generate from selling their output of goods and services in markets – business revenues.

The meaning of revenue
Revenue (or turnover) is the income generated from the sale of output in product markets. There are two main revenue concepts to grasp at this stage:
  • Average Revenue (AR) = Price per unit = total revenue / output
  • Marginal Revenue (MR) = the change in revenue from selling one extra unit of output






























Average and marginal revenue – the important relationships
In our example in the table above, as price per unit falls, demand expands and so too does total revenue, although because the demand curve is downward sloping, the average revenue falls as more units are sold. This causes marginal revenue to decline. Eventually once marginal revenue becomes negative, a further fall in price (e.g. from $220 to $190) causes total revenue to fall.
Because the price per unit is declining, total revenue is rising at a decreasing rate and will eventually reach a maximum (see the next paragraph).

Elasticity of demand and total revenue
When a firm faces a perfectly elastic demand curve, then average revenue = marginal revenue (i.e. extra units of output can all be sold at the ruling market price). However, most businesses face a downward sloping demand curve! And because the price per unit must be cut to sell extra units, therefore MR lies below AR. In fact he MR curve will fall at twice the rate of the AR curve. You don’t have to prove this for the exams – but it is worth remembering that the marginal revenue curve has twice the slope of the AR curve!
The total revenue for any business is maximised when marginal revenue (MR) = zero. Once MR becomes negative, total revenue falls if extra units are sold. This is shown in the next diagram.
Elasticity of demand and total revenue
Elasticity of demand and total revenue


Elasticity of demand and total revenue


Total revenue is shown by the area underneath the firm’s demand curve (average revenue curve).

Total revenue is shown by the area underneath the firm’s demand curve (average revenue curve).
Total revenue is shown by the area underneath the firm’s demand curve (average revenue curve).


Total revenue is shown by the area underneath the firm’s demand curve (average revenue curve).


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MARGINAL REVENUE CURVE:

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  • A curve that graphically represents the relation between the marginal revenue received by a firm for selling its output and the quantity of output sold. A firm maximizes profit by producing the quantity of output found at the intersection of the marginal revenue curve and marginal cost curve. The marginal revenue curve for a firm with no market control is horizontal. The marginal revenue curve for a firm with market control is negatively sloped and lies below the average revenue curve.



Hi girls here is the answers to the revision booklet. Aim to do 1-2 questions per topic in preparation for the test this term. Aim to complete the book in time for the end of year exams (school &ncea). Click on the link external image x-zip.png 90629 revision exercises - Answers.docx || ||

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measuring profit

Profit = the difference between total revenue and total cost
Profit per unit = AR - ATC
A firm adds to profits if marginal revenue from selling an extra unit is greater than the marginal cost of production
Break-even output occurs when AR=ATC
Revenue maximization is when MR = zero
Profit maximisation occurs at the output where MR = MC
TYPES OF PROFIT
In economics there is no unique definition of profit!
NORMAL PROFITS - are defined as the minimum level of profit required to keep the factors of production in their current use in the long run. Normal profits are included in the ATC curve, thus if the firm covers its ATC it is making normal profits. where AC=AR
SUPERNORMAL PROFIT - is any profit in excess of normal profit. Also known as supernormal profit or economic profit. When firms are enjoying abnormal profits in an industry there is an incentive for other producers to enter the industry to try to acquire some of this profit for themselves. Where AC < AR
SUB-NORMAL PROFIT - is any profit less than normal profit. In the long run a firm will leave an industry if it continues to make only sub-normal profits. Also called an economic loss. Where AC > AR
ILLUSTRATING PROFIT MAXIMISATION
The firm maximises profit when marginal cost equals marginal revenue.
It can sell output Q1 at price P. The profit per unit = P - ATC.

Total profits are shown by the yellow shaded area. Because price exceeds average total cost (and normal profits are included in the average cost curve) we can say that the firm is earning supernormal profits in this situation





external image profitmax1.gif
external image profitmax1.gif

Total profits are shown by the yellow shaded area. Because price exceeds average total cost (and normal profits are included in the average cost curve) we can say that the firm is earning supernormal profits in this situation

A change in marginal costs causes a change in the profit maximising level of output. In the diagram above, lower variable costs cause MC to shift from MC1 to MC2. The profit maximising output expands from Q1 to Q2. Higher costs would cause a contraction of output because of an upward shift in the marginal cost curve.
external image profitmax2.gif
external image profitmax2.gif

Profits rise when demand for the goods or services that the business is producing increase, or when production costs fall allowing the business to increase the profit margin on their output. When the macro-economy is doing well, we expect to see rising profit levels.