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ECO254-1102B-04 Introduction to MicroeconomicsPhase 1 Individual Project (Defining Marginal Analysis)Sabrina MergenthalerColorado Technical UniversityProfessor Jeffrey Leeson

The following presentation will discuss the basic building blocks of microeconomics. Due to America being a market economy, it is valuable to understand how economics determines the price of goods and services; how government and industry policies are influenced by economics; how the influence of economics affects our international trade; and how it impacts our daily lives. In failing to understand the workings of economics, we fail ourselves as a nation. Our economy cannot support the nation taking without giving back. If youve ever read the book by Shel Silverstein, The Giving Treeyou can see what taking without giving back does. Think of the tree as the government though, shelling out money to everyone who wants some. Eventually, there will be no money left to give, just a stump to sit on. The tree may have been happy in the end, and perhaps so will the government. After all, when America is just a stump, what more can the people do to go against the government? However, this is not a class on government control. This class is on microeconomics. Its purpose is to open the eyes of the students to wiser spending habits. So lets discuss how it works.1

Economics

Lets first take a look at economics. In economics, issues are made up of the everyday choices people must make to achieve their goals. While people are never short of hopes, dreams and wishesthere is unfortunately only a limited amount of resources available to make these things a reality. This is called scarcity. Most people do not have a money tree growing in their backyard, which means if they want to own a Mercedes Benz they must be wise with their money, or at least know someone who is willing to part with theirs. In business, these types of decisions may fall more on how to produce products or provide services, and may even include solving issues on quantity of services or products. The study of these decisions is called economics. The government, consumers, business ownerseveryone must make these types of decisions at some point in life.Economics must answer the questions what, how and who. What goods or services will be produced? What type of car? What color dress? Etc.How will the goods be produced? How will we provide services? How will I pay for that car or dress? Etc.Who will buy the goods or services? Who will drive that car? Who will ride shot-gun? Who will I bring to the prom? Etc.Economics analyzes the marketthat is the economys buyers and sellers and how they come together to trade goods and services. At the business end of economics there are three basic ideas that are of extreme importance to become familiar with:People are rational,People respond to incentive,Decisions are made at the margin (Hubbard, O'Brien, 2010).

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What is Marginal Analysis?

Economists make sense of the market by developing methods to calculate the margin (the benefit or loss from producing additional units of a product or service). This method is called marginal analysis. Marginal analysis involves comparing marginal costs and marginal benefits. People perform a marginal analysis for almost everything they decide to do in life. For instance, choosing to go to college or not involves comparing the benefits of obtaining a college degree, versus not having that degree. Companies use marginal analysis in much the same way. In deciding to hire more employees, or produce more goods, the company must be assured that the benefits outweigh the cost of the additional production, or employee. When you think at the margin, you are essentially considering the amount you must put in to get the best benefit (Leeson, 2011). By definition, marginal analysis is a technique used in economics that reviews minute changes in key variables. It is the basic analytical approach used to study markets, production, consumption, business cycles, and economic policies. It reflects how most economic decisions are made, as welllends itself to mathematical and graphical analysis (Marginal Analysis, 2011). 3

Marginal Benefit

Marginal Cost

Marginal Cost- additional cost incurred by providing one more unit of service or product.Marginal Benefit- the additional benefit of making or selling additional service or product.

JeffreyLeeson

Micro-

Whats marginal Cost and benefit?Defining Marginal Cost and Marginal Benefit

Professor Leeson of Colarado Technical University defines marginal cost in his live chat, as the additional cost incurred by providing one more unit of service or product. He also states that the marginal benefit is the additional benefit of making or selling additional services or products. As we previously mentioned, these two components lend themselves to the marginal analysis in order to develop a solution. So what is meant by these terms?In business, when we talk about marginal, we are talking about additionaladditional product, additional workers, additional supplies, and so on. In order for a business to decide whether or not to take on these additions, they must consider the cost and the benefit of doing so. Marginal cost, (economic symbol MC) is how much more money it will take to produce or service that additional unit. For instance, if a company produces bicycles, and they wish to produce more, they will need to consider how much more in supplies and equipment will be necessary to make more bikes. Additionally, making more bicycles may force the company to incur wage costs, since additional employees and longer hours may be necessary to successfully produce more bicycles. In terms of benefits, the company will look into how much is made from the sale of each bicycle as well as how well sales are performing. These make up the marginal benefits (symbolized in economics as MB). If there is demand for a larger quantity of bicycles on the market, and the bicycles are sure to sell for more than the cost of producing the bicycles then the company will most likely produce more bicycles. However, if sales are not rapid enough, or the cost to create more bicycles outweighs the benefits, chances are that the company will choose not to produce more bicycles. Failing to pay attention to the marginal costs and benefits can be disastrous to a company. The equation demonstrated by MB=MC reasons that the optimal decision continues any activity until the marginal cost is equivalent to the marginal benefit. This makes up the foundation of marginal analysis (Hubbard, O'Brien, 2010).4

Marginal Analysis in the World of Economics

As you see, much of what we have already discussed focuses on how marginal analysis is used in the world of economics. Lets take a deeper look, though. Marginal analysis has been identified as a tool for solving problems to determine how much of something should be done to achieve a goal. We use graphs to mark the point where price, quantity, marginal cost and marginal benefit of a product meet for success. By that I mean, at what price will consumers purchase the most product, and at what costs and benefit to the company. Keep in mind that resources such as workers, materials, and machinery are limited. Thus, only a limited amount of goods and services can be created. Economist use this knowledge to create models of markets, consumer behavior, production decisions, and the aggregate economy. These models have been used to expose interactions, implications, and conclusions about the economy (Marginal Analysis, 2011). 5

AffectingGoods and ServicesEfficiencyEquityMarket economy

In turn, societies are forced to accept trade-offs. Trade-offs occur because the scarcity of resources for one product means the over production of another product with more abundant resources. For instance, the amount of cows on a farmers plot far overwhelms the amount of bison. Therefore, the farmer produces more beef product than bison. Suppose that there are two different farmers, one that produced cow products and the other produced the bison products. At the grocery store, a consumer would likely opt to buy the less expensive cow product than the bison product. This is an example of opportunity cost. Opportunity cost refers to the highest valued amount that must be sacrificed to engage in any activity. In this case, the activity is eating. The consumer is giving up the higher costing and more lean meat for a lower costing, less quality meat. The same holds true throughout the world of economics. Trade-offs must be made to stay afloat and make profit. These trade-offs are taken into consideration when deciding what goods and services will be manufactured; how they will be manufactured, and who will receive the products (Hubbard, O'Brien, 2010)..6

Efficiency

Static EfficiencyProductive EfficiencyAllocative EfficiencyDynamic EfficiencySocial EfficiencyTechnical EfficiencyPareto Efficiency(Economic Efficiency, D.N.K)

Several types of efficiency

Marginal analysis is the study that promotes efficiency. Efficiency is one of the most important concepts in economics. The term refers to how well an economy distributes scarce resources to meets the needs and desires of consumers. Production of a good is considered to be efficient when that good is manufactured at the lowest cost possible (Economic Efficiency, 2011). Technological efficiency is a matter of engineering. Taking into consideration what is technologically possible, something can or cannot be done. On the other hand, economic efficiency depends on the cost of the factors that make up a product. Therefore, something that is technologically efficient may not always be economically efficient, however, something that is economically efficient is always technologically efficient (Economic Efficiency, 2011). It is important to understand, though, that any change that lowers the quality of the good and lowers the cost of production does not increase the economic efficiency of that good. The concept of economic efficiency is only relevant when the quality of goods being produced is unchanged (Economic Efficiency, D.N.K.). A personal example lies in Wii remotes versus Nyko remotes. Bother remotes work for the same gaming system. Nyko sells their remote for $50 less than Wii sells its remotes. However, the quality of the remotes is not equivalent. The Nyko remotes does not respond as well at the Wii version. Thus, the Nyko product maintains efficiency in price, but by far dies not compare in quality. Other types of economic efficiencies include:Static Efficiency which narrows in on how much output can be produced from a supply of resources and considers whether producers are charging a price that adequately reflects the cost of production used to produce the good or a service. Productive Efficiency occurs when manufacturers minimize the waste of resources in their production processes. It is achieved when the output is produced at minimum average total cost (AC).Allocative Efficiency occurs when value is placed on a good or service by a consumer (reflected in the price they are happy to pay) that is equivalent to the cost of the resources incurred in production. Dynamic efficiency refers to efficiency gained over time. Dynamic efficiency involves introducing new technology and working practices to reduce costs over time.Social efficiency is the optimal distribution of resources in society. It takes into account all external costs and benefits as well as internal costs and benefits. Social Efficiency occurs at an output where Marginal Social Benefit (MSB) = Marginal Social Cost (MSC). It is similar to Pareto efficiency.Technical efficiency is producing the maximum output from the minimum quantity of inputs, such as labor, capital and technology. Some might say that the current President of the United States is technically efficient: making do with what he has.Pareto efficiency occurs when it is impossible to make one party better off without making another party worse off. In Americas economy this is attempted by the classic idea of taking from the rich and giving to the poor. It is a dangerous socialist point of view, and threatens to damage our country with failure across the board (Economic Efficiency, D.N.K.).

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Creating Equity

What is Equity?

Marginal analysis reflects the study of how disbursement of resources affects people. Equity occurs when this disbursement is considered fair. In America, this has never been the case, and never will be the case. Generally, equity acts as trade-off for efficiency in the production of goods. This is due to the belief that people who earn higher incomes should be taxed at higher rates to support the programs that increase the benefits received by those who earn low wages (Hubbard, O'Brien, 2010).The danger in this idea is that it does not encourage people to work hard, or to open new businesses. Instead, it influences businesses to produce their goods and provide jobs overseas where taxes and wages are generally lower. In turn, new jobs are not created in America, fewer goods and services are created, there is less competition among industries, little savings occurs for the future, and our economy is not stimulated (Neal Boortz). 8

Our Market Economy

Centrally Planned EconomyGovernment driven

Mixed EconomyConsumers/FirmsGovernment

Market EconomyConsumers/Firms

Driven by

Marginal analysis is a simple equation by which so much of our economy and lives depend upon. We have seen how it influences what products are made, how much those products are sold for, and who they are sold to. Now lets look at how it impacts our economy as a nation. America operates by a market economy (Leeson, 2011). That means consumers and companies have more control than the government. In other countries, where a centrally planned economy, or a command economy exists, the government is the sole control unit. Although America only accounts for approximately five percent of the world population, she produces about 25 percent of the global economic output. Much of the decisions of what to produce, how to produce and who to produce for is determined by the free market of America (US Market, D.N.K.). It is because of the marginal analysis that we are as a nation, able to make such informed, rational decisions.There are also countries which operate under a mixed economic system, which relies on government and market to make decisions. However, America values capitalism and remains a free market, because of firm beliefs in free enterprise. However, Americans have also looked to government regulate companies that appeared to develop too much power which could ultimately defy market principles. They have relied on government to address matters that the private economy overlooks, from education to protecting the environment. Despite their advocacy of market principles, America has used government to nurture new industries, and at times even to protect American companies from competition (US Market, D.N.K.).9

Marginal costs of becoming a licensed contractor$250 exam fee$75 yearly reinstatement feeTime spent preparing for testRisk of losing license

Marginal Benefits of becoming a licensed ContractorCan charge more for servicesCan become certifiedBetter reputationBecome more of an asset to your company

Marginal Analysis: An example

For an example of marginal analysis in action, I have taken a personal experience. My husband was the sole proprietor of his private contracting business. Due to the heavy amount of traffic in his industry, he was advised to obtain a license. In the state of Georgia, it is not necessary for one to be a licensed contractor in order to perform services for a fee. In response to the advice, my husband weighed the benefits of obtaining the license. The benefits included his being able to charge more for services based on his licensing; he could then become certified in specific areas of contracting and build a reputable business, and if he chose to apply to work with a large contracting company, he would be a more valuable asset with an ability to be paid at a higher rate.However, he was faced with the up front cost of the testing, which was $250. After that, a yearly fee of $75 was necessary to maintain the license. He would have to invest time in studying and preparing for the test. Failure did not mean a refund, after all. In addition, there was a risk of losing the license over consumer complaints that went wrong (which in home repair, can happen a lot).Although, the benefits were clearly worth it, my husband chose not to obtain a license. He had never had a problem finding work that paid him well, and most homeowners in fact opted for unlicensed workers due to the lower charges associated with them. Thus, it is likely that he received more business by not having a license. 10

Marginal Analysis conclusion

Marginal analysis is a key concept in economics. It studies how cost and benefits change as incremental changes are made to production. People use marginal analysis everyday for making decisions as simple as getting a hair cut to more important matters, such as waging a war. The costs are weighed as time, money, or anything that is unredeemable. The benefits are the gains to be had from making these decisions. The benefits should at the very least be equivalent to the cost, but moreover, should exceed cost. These ideas are called thinking at the margin. Sometimes, people tend to think at the margin of benefiting only a select group, which is harmful to our nation. America is a capitalist, or market economy. She survives on the principles that consumers and companies are in control. When we fail to realize this, we doom her strong existence. 11

Marginal Analysis. (2011). AmosWEB Encyclonomic WEB*pedia. Retrieved from http://www.AmosWEB.comMoffatt, Mike. (D.N.K.). What does Economic Efficiency mean? Retrieved from http://economics.about.com/od/productivity/f/economic_eff.htmEconomic Efficiency. (2011). Retrieved fromhttp://tutor2u.net/economics/content/topics/competition/efficiency.htmEconomic Efficiency. (D.N.K.). Retrieved from http://www.economicshelp.org/microessays/costs/efficiency.htmlUS Market Economy. (D.N.K.). Retrieved fromhttp://www.economywatch.com/market-economy/us-market-economy.htmlReferences