Micro2AP - Appendix: Optimization Marginal Analysis Most...

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Unformatted text preview: Appendix: Optimization Marginal Analysis Most daily business and economic decisions are based on marginal analysis, not on totals or averages . Decisions are made by comparing marginal benefit of an action (MB) to its marginal cost (MC). If MB > MC it is rational to take the action, otherwise, discard it. Example: Consumer Theory ; To maximize utility, a consumer compares marginal utility (MU) of the good to its price. If MU > P , consumer buys more units of the good. If MU < P , consumer buys less . Consumers utility is maximized at the quantity that MU = P. Appendix: Optimization Example: Theory of Firm and Production : A business hires labor as long as the value of the marginal product of the last labor hired (VMPL) is greater than wages (W) paid to labor. As long as VMPL > W , business will hire more labor. If VMPL < W , business will fire the labor . When VMPL = W , an optimum level of hiring is achieved. A business earns a marginal profit from selling a good as long as marginal revenue from selling the good (MR) is greater than marginal cost of the good (MC), MR > MC . Appendix: Optimization What is Marginal? Marginal means incremental . Marginal utility of a good for a consumer is the increase in total utility for one more unit increase in consumption of the good. Marginal product of labor is increase in total product due to one more unit increase in labor, and marginal cost of producing a good is addition to total cost due to one more unit increase in production of that good, and so on. If MR > MC , the firm will sell more goods . If MR < MC , the firm will sell less goods . Profit is maximized or loss is minimized when MR = MC . Example Continued: Appendix: Optimization For a mathematical function y = f(x) derivative of the function, dy/dx , is the rate of change in y per small units of change in x. That is, Limit of dy/dy, as dx 0. In economics, marginal is the same as derivative. Examples: For a total utility function U = u(Q), marginal utility (MU) is MU = dU/dQ....
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Micro2AP - Appendix: Optimization Marginal Analysis Most...

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