03. The Margin

03. The Margin - Economic Margins and Rationality The...

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The margin is where billions of choices are made every day, where individuals choose: to drive, to drink, to speed, to vote, to lie, to study, to work, to play,… The starting point for microeconomics is the analysis of individual choice. That approach embodies the key assumptions of rationality and self- interest. Simply stated, the “economic man” carefully weighs options and chooses alternatives that provide the greatest personal benefits. For those of you who are higher-minded, the more important questions relate to how that tendency (toward self-interest) translates into social good (or bad). Adam Smith focused on how the pursuit of self-interest combines with competitive markets to the benefit of society; Thomas Hobbes and Jeremy Bentham focused on how such pursuits should be restrained. Either way, the broader objective is to promote (or maximize) net social welfare (benefits minus cost). A. Marginal Cost How much does it cost to produce or acquire “one more” unit? In the case of greenhouse gases, the question was turned around: how much does it cost to get rid of, or to avoid producing, one more unit? This is a very lofty question with a complex answer. We examined some crude estimates of this, with cost measured in terms of foregone GDP. At a personal level, consumers usually can associate marginal cost with price. Prices may vary a little over time and from place to place, but consumer usually can buy as much as they want at the same price. At the production level, individual producers may experience falling marginal costs (producing 200 units may cost less than twice as much as 100 units), but such gains in efficiency are limited; ultimately marginal costs tend to rise for individual producers, just as the “law of increasing cost” suggests for an economy as a whole. For now: think in terms of rising MC curves. $/ton 0 MC MC 1 60 320 480 640 20 . 45 100 . 77 . . Millions of tons / year Figure 1 10% 20% 30% 40% A D C B Returning to the marginal cost of reducing greenhouse gases, let’s focus on the distinction between marginal and total. According to the approximate numbers in Figure 1, the first 10% can be removed at a constant cost of $20 per ton. Up to and including the 160 millionth ton, the cost per unit is $20. Removing all 160 million tons would therefore cost $3.2 billion, represented by area A. Beyond the 10% threshold, MC rises above $20 per ton. At the 20% level, the last ton removed (the 320 millionth) costs $45. The second 10% cost more than the first – the actual number is equal to area B. The point: the total cost is equal to the area under the marginal cost curve. So the total cost of meeting the conditions of the Kyoto protocol would be the sum of areas A, B, C, and D, 1 with each additional 10% reduction costing substantially more than the preceding 10% reduction. 1
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This note was uploaded on 05/09/2008 for the course ECN 212 taught by Professor Nancy during the Fall '07 term at ASU.

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03. The Margin - Economic Margins and Rationality The...

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