Econ 201 Principles of Microeconomics

1. Econ 201Principles of Microeconomics Lecture #1.2 1-06-2009 Economics as a Marginalist Paradigm

2. Why Marginal Anything? • According to economic theory: • Decisions are made at the margin • Firms • Decision on how much to supply is determined by comparing additional (marginal) costs of producing one more unit to additional (marginal) revenue • Consumers • Compare marginal value (in use) of consuming the good versus the additional (marginal) cost of purchase (or price paid)

3. Today • Look at how to compute (and why it’s important): • Marginal Cost of production for a firm • Derived from total costs of production • Total costs only determine whether or not firm enters an industry, not how much to produce/supply • Marginal Value of consumption for an individual • Derived from the individual’s demand curve • People compare at the margin to determine how much to buy

4. Marginal Costs • What do we mean by marginal costs? • incremental, or additional, costs of producing one more unit of output • Difference in total costs of producing one more unit • Marginal cost of the 4th unit = Total Costs of the 4th unit minus the Total Costs of the 3rd unit MC[4] = TC[4] – TC[3]

5. A Numeric Example • From Alchian and Allen

6. A Numeric Example • What Are the Marginal Costs

7. All of the Numbers

8. What Do They Mean? Marginal and Total Costs increasing at Increasing rate Total and Marginal Costs Marginal Costs at Minimum, TC increasing at dec rate

9. What’s It Mean to a Supplier? • Firm’s supply decision • Supply up to the point where p = MC • Profit maximizing point Profit Max MR = MC

10. From the Demand Side • First Law of Demand • What Does Law Of Demand Mean? • all other factors being equal, as the price of a good or service increases, consumer demand for the good will decrease and vice versa.  • Investopedia explains Law Of Demand... • summarizes the effect price changes on consumer behavior. For example, a consumer will purchase more pizzas if the price of pizza falls. The opposite is true if the price of pizza increases. • http://www.investopedia.com/terms/l/lawofdemand.asp

11. A Demand Example

12. Consumer’s Marginal Value • Some basic definitions • Total Willingness-to-pay: “value in use” • How much would you be willing to pay for x units of the good than go entirely without? • Equals the area under the demand curve up to xunits WTP for 4 units

13. Computing Marginal Value

14. Total and Marginal Value Price x Qty Dem Area under Demand Difference in TV(3)-TV(2) MV is also equal to price paid

15. In Graphic Terms Note: (again) price = marginal value Consumer is willing to buy up to P = MV

16. What Have We Learned? • How to compute marginal or incremental values • Marginal cost: the additional (change in Total Costs) of producing one more unit • Marginal value: the value to a consumer of purchasing one more unit

17. The Bigger Lesson • Sell rule for firms • Firms will supply up to the point where the MC of producing the next unit are just equal to the price it receives for the good • First law of supply: supply curves will be upward sloping • Buy rule for consumers • Consumers will buy up to the point that price equals MV • First law of demand: demand curves are downward sloping • Negative slope  diminishing marginal value of consuming next unit