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chap3 Optimimization_1

# chap3 Optimimization_1 - Chapter 3 Marginal Analysis for...

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Chapter 3: Marginal Analysis for Optimal Decision Making Optimization is a process that finds a best, or optimal, solution for your model. In other words given your constraints optimization finds the best possible solution to the problem at hand An optimization problem involves the specification of three things: Objective function to be maximized or minimized ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ___ Activities or choice variables that determine the value of the objective function ________________________________________________________________________________ ________________________________________________________________________________ __ Any constraints that may restrict the values of the choice variables ________________________________________________________________________________ ________________________________________________________________________________ 1

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________________________________________________________________________________ ___ Thus, all economic problems and managerial decision-making problems are optimization problems. E.g. Maximization or minimization problem. In other words all managerial and economics decisions are essentially optimization problem. A manager’s decision is optimal if it leads to the best outcome under a given set of circumstance Figure 1: The optimal level of activity using the Total approach 2
Net Benefit (NB) Difference between total benefit (TB) and total cost (TC) for the activity NB = TB – TC NB T T 1,000 Level of 2,000 4,000 3,000 A 0 1,000 600 200 Total benefit and total cost (dollars) Panel A – Total benefit and total cost A 0 1,000 600 200 Level of Net benefit (dollars) Panel B – Net benefit curve G 700 F D’ D C’ C B B’ 2,310 1,085 NB* = f’’ 350 = A* 350 = A* M 1,225 c’’ 1,000 d’’ 600 3

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Thus, generally Economic Efficiency arises when the difference between Total Cost and Total Benefit is the largest (implying they have equal slopes). The level that maximizes net benefit is called the optimal level of the activity (A*), which we distinguish from other levels of activity with an asterisk: A*. ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ______ 4
Optimization using Marginal Approach While the total approach serves to define and describe the optimal level of activity; it does not explain why net benefit rises, falls, or reaches a peak.

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chap3 Optimimization_1 - Chapter 3 Marginal Analysis for...

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