Topic 1 MB and MC - Marginal Cost and Marginal Benefits lecture notes PDF

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Marginal Cost and Marginal Benefits lecture notes...

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Topic 1 cost and benefits MC is the extra cost of undertaking one additional unit of an activity MB is the extra benefit of undertaking one additional unit of an activity MC = change in total cost/change in total quantity = ∆TC/∆Q = (new TC – old TC)/(new Q – old Q) MB = change in total benefit/change in total quantity = ∆TB/∆Q = (new TB – old TB)/(new Q – old Q) Each pizza = $10 Say you return home to your parent’s after a very long day out, very hungry and very tired. When you get there, they surprise you with your favourite pizza, which they buy for $10. They have 4 of them. From this you can see the calculation for total cost (TC) below in the table. We can calculate MC (i.e. the cost of each additional pizza) from the information. Each extra pizza, say going from 1 to 2, then from 2 to 3, and finally from 3 to 4 is calculated below using the formula provided above. In each case MC = $10 in this example as each pizza costs $10. So a simple example. 1 Q

TC (P*Q)

1

10*1 = $10

MC

TB

10*2 = $20

3

10*3 = $30

Decisio n

$100 (20-10)/(2-1) = 10/1 = 10

2

MB

(170-100)/(2-1) = 70/1 = 70

EAT

(200-170)/(3-2) = 30/1 = 30

EAT

$170 (30-20)/(3-2) = 10/1 = 10 $200

(40-30)/(4-3) = 10/1 = 10 (205-200)/(4-3) = 5/1 = 5 NO 4 10*4 = $40 $205 Before you eat that first pizza your mum asks you ‘how much would you have paid for this pizza?” You say, because eyou are so hungry, that you would have been willing to have paid $100 for it. That means your total benefit (TB) of eating that first pizza is $100. You finish it, and your parents put the 2nd pizza on the table. Before you can eat it they ask, “how much would you have paid for both pizzas?” and you say $170 for the two. This shows you that you are (a) still hungry but (b) not as hungry as before you ate the first, because this shows that going from zero to 1 pizza gave you a MB of $100 (not shown, but if we did the calculation would have been (100-0)/(1-0) = 100/1 = 100), but going from 1 to 2 pizzas satisfied you by a value of $70 Finish the 2nd and the 3rd arrives-your parents ask again “how much are the 3 pizzas worth to you?” and not being so hungry anymore but still a bit hungry you say $200; this means the MB of going from 2 to 3 pizzas is $30. Finally they give you the 4th and that is just too much for you-you are really full but you still can eat a bit if forced-“now”, says daddy dearest, “how much for 4?” and you say $205, so really a MB of going from 3 to 4 pizzas is very small ($5). So how many pizzas should you eat? 1 If each pizza had a different price (say different toppings) then MC would be different. For example, imagine pizza no. 3 was $8. Then TC for 3 pizzas is $28 and MC of going from 2 to 3 pizzas is (28-20)/(3-2) = 8/1 = $8.

If MC...