Output Expansion and Contraction Decisions: A profit-maximising firm reaches equilibrium by equating marginal revenue with marginal cost. It’s natural for people to compare costs and benefits, but often we look at total costs and total benefits, when the best choice requires comparing how costs and benefits change from one option to another. Economists make an assumption that humans make decisions "on the margin". These next questions allow you to get as much practice as you need, as you can click the link at the top of the first question (“Try another version of this question”) to get a new set of questions. This is because it is assumed that the fixed costs have already been incurred and that the other costs are the variable costs. From a business’s point of view, marginal cost is the additional cost of one more item produced. This doesn’t make it any less real, however. Output Expansion and Contraction Decisions 4. TOS4. Should you rent a beach house for one week or two? The marginal cost of the first scoop of ice cream is $3.00 because you have to pay $3.00 more to get one scoop of ice cream than you do to get zero scoops of ice cream. This subtle concept is easier to grasp with examples. Generally speaking, marginal benefit is the difference (or change) in what you receive from a different choice. The first week costs $2,000. Purchasing may be worthwhile where suppliers have specialized equipment and can supply at reduced prices but it is necessary to consider the effect of fixed costs on internally made products. The amount of benefit a person receives from a particular good or service is subjective; one person may get more satisfaction or happiness from a particular good or service than another. Privacy Policy3. Share Your Word File In short, you might think of marginal analysis as “change analysis.” Marginal analysis is used throughout economics. Figure 1. Content Guidelines 2. The amount of benefit you get can also change. The budget constraint framework helps to illustrate that most choices in the real world are not about getting all of one thing or all of another—we rarely decide “all burgers” or “all bus tickets.” Options usually fall somewhere on a continuum, and the choice usually involves marginal decision-making and marginal analysis. How Individuals Make Choices Based on Their Budget Constraint. Similarly, the choice of an optimum-product mix depends on the average contribution margin of each product. For some people, the answer will be yes. The budget constraint framework helps to illustrate that most choices in the real world are not about getting all of one thing or all of another—we rarely decide “all burgers” or “all bus tickets.” Options usually fall somewhere on a continuum, and the choice usually involves marginal decision-making and marginal analysis. The following points highlight the five main applications of marginal analysis. Use this quiz to check your understanding and decide whether to (1) study the previous section further or (2) move on to the next section. If a firm suffers from capacity constraints it has to expand, or purchase certain items from an external source. For example, you might enjoy the ice cream more on a hot day than on a cold day. Marginal analysis is an examination of the additional benefits of an activity compared to the additional costs incurred by that same activity. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. Thus, while the marginal cost of the first week’s rental is $2,000, the marginal cost of the second week’s rental is $1,600. Marginal decision-making means considering a little more or a little less than what we already have. Marginal decision-making means considering a little more or a little less than what we already have. From a consumer’s point of view, marginal benefit is the additional satisfaction of one more item purchased. The applications are: 1. She will also want to work the 10th hour as she receives a net benefit of #3 (marginal benefit of $15, marginal cost of $12). Maximum resources are to be allocated to the production of those commodities which make the maximum contribution towards overhead as also towards fixed cost. An economically rational decision-maker would ask, Is the marginal benefit (access to the weight room) worth the marginal cost (an extra $10 per month)? The answer to this question can easily be found out by applying the standard marginal principle. This information is shown in the following table. A firm will continue to spend money on advertising so long as the marginal revenue (after advertising) exceeds marginal cost (after advertising), or, marginal cost is less than marginal revenue. Commodity X also shows the lowest rate of contribution per man hour, and if manpower is the limiting factor, again this article will be purchased outside. So long as the marginal efficiency of capital is greater than the rate of interest, a firm will add to its stock of capital. Optimal Advertising Decisions. A firm will go on adding new products to its product line so long as the marginal revenue generated by a product exceeds its marginal cost. This illustrates the key rule of marginal analysis: Marginal cost = the change in total cost from one option to another. For others, it will be no. If we return to the recreation center example above, suppose that the basic membership is $30 per month, while the full membership is $40 per month. If an action's benefits outweigh its costs, it should be taken. The amount of benefit you get can also change. But consider the cost by week. Either way, marginal analysis is an important part of economic rationality and good decision-making. How, then, do you decide on a choice? These Could Be Personal Applications Or Applications That You Have Used On The Job. For example, you might enjoy ice cream more than your friend who is allergic to dairy. It is a technique of demand manipulation. Should you buy just one charm for $4, or all of them for $12? When machine power is the limiting factor, X again appears to be the first choice for external purchase, since it yields the lowest rate of contribution per machine, and Z is the second choice at a contribution of Rs. However, it has the effect of raising both cost and price. You’ll have more success on the Self Check if you’ve completed the Reading in this section. So long as MR is greater than MC, the firm will expand its volume of output (sales). From a business’s point of view, marginal cost is the additional cost of one more item produced. An economically rational decision-maker would ask, Is the marginal benefit (access to the weight room) worth the marginal cost (an extra $10 per month)? © BrainMass Inc. brainmass.com October 2, 2020, 5:14 am ad1c9bdddf https://brainmass.com/economics/production/marginal-analysis-in-business-and-personal-life-examples-576474 Solution Preview. We decide by using marginal analysis, which means comparing the costs and benefits of a little more or a little less. Suppose you typically spend a week at the beach for vacation, but this year you earned an annual bonus from your job. Product-Line Decisions 5. This next question allow you to get as much practice as you need, as you can click the link at the top of the question (“Try another version of this question”) to get a new question. With commodity X the purchase price is less than the marginal cost; so it is profitable to buy outside. An economically rational decision is one in which the marginal benefits of a choice are greater than the marginal costs of the choice. A common real-life example of diminishing marginal utility is the all-you-can-eat-buffet, according to Investopedia. Generally speaking, marginal cost is the difference (or change) in cost of a different choice. Thus, while the marginal cost of the first week’s rental is $2,000, the marginal cost of the second week’s rental is $1,600. The answer is that you compare, to the best of your ability, the marginal benefits with the marginal costs. You can choose whether to buy one, two, or three scoops of ice cream. Should you rent a beach house for one week or two? Practice until you feel comfortable doing the questions and then move on. Generally speaking, marginal benefit is the difference (or change) in what you receive from a different choice.
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