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UND / Economics / ECON 201 / xiao wang asu

xiao wang asu

xiao wang asu

Description

School: University of North Dakota
Department: Economics
Course: Principles of Microeconomics
Professor: Xiao wang
Term: Fall 2016
Tags: Microeconomics, Economics, UND, University, north dakota, paul, krugman, Robin, wells, fourth, and edition
Cost: 25
Name: Microeconomics ~ Chapter 9 ~ Decision Making by Individuals and Firms
Description: These notes cover chapter 9 which is about decision making by individuals and firms. Topics covered are costs, benefits and profits. Marginal analysis. Behavioral economics.
Uploaded: 02/05/2017
13 Pages 15 Views 0 Unlocks
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How many miles do you go before an oil change in your car?




How many days before you do your laundry?




“Either-or” decisions “How much” decisions Tide or Cheer?



Chapter 9 ~ Decision Making by Individuals and Firms Economists use the concepts of explicit costs and implicit costs to compare the  relationship between opportunity costs and monetary outlays. We’ll discuss these  two concepts first. Then we’ll define the concepts of accounting profit and  economic prIf you want to learn more check out Chapter 1: What Is Personality?
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ofit, which are ways of measuring whether the benefit of an action is  greater than the cost. Armed with these concepts for assessing costs and benefits,  we will be in a position to consider our first principle of economic decision  making: how to make “either–or” decisions. Always think in terms of opportunity cost when making decisions. Opportunity Cost = Explicit Costs + Implicit Costs An explicit cost is a cost that requires an outlay of money. ∙ Money out-of-your-pocket An implicit cost does not require an outlay of money. It is measured by the value,  in dollar terms, of benefits that are forgone. ∙ What you give up; such as, personal resources (time) and capital (interest) When economists use the term profit, they are referring to economic profit, not  accounting profit. Accounting profit is equal to revenue minus explicit cost. Accounting Profit = Revenue – Explicit CostsEconomic profit is equal to revenue minus the opportunity cost of resources  used. It is usually less than the accounting profit. ∙ Economic Profit = Revenue – Opportunity Costs ∙ Economic Profit = Revenue – Explicit Costs – Implicit Costs ∙ Economic Profit = Accounting Profit – Implicit Costs Capital is the total value of assets owned by an individual or firm—physical assets  plus financial assets. The implicit cost of capital is the opportunity cost of the use of one’s own  capital—the income earned if the capital had been employed in its next best  alternative use. “How Much” versus “Either-or” Decisions “Either-or” decisions “How much” decisions Tide or Cheer? How many days before you do your laundry? Buy a car or not? How many miles do you go before an oil  change in your car? An order of nachos or a sandwich? How many jalapenos on your nachos? Run your own business or work  for someone else? Prescribe drug A or drug B for  your patients? How many workers should you hire in your  company? How much should a patient take of a drug that  generates side effects? Graduate school or not? How many hours to study? According to the principle of “either–or” decision making, when faced with an  “either–or” choice between two activities, choose the one with the positive  economic profit. 1. If economic profit is greater than zero, your first option is best2. If economic profit is less than zero, your second option is best 3. If economic profit is equal to zero, your option is undeterminate ∙ All costs are opportunity costs. They can be divided into explicit costs and  implicit costs. ∙ An activity’s accounting profit is not necessarily equal to its economic profit. ∙ Due to the implicit cost of capital—the opportunity cost of using self-owned  capital—and the opportunity cost of one’s own time, economic profit is often  substantially less than accounting profit. ∙ The principle of “either–or” decision making says that when making an  “either–or” choice between two activities, choose the one with the positive  economic profit. Marginal Analysis ~ Marginal Cost & Marginal Benefit The marginal cost of producing a good or service is the additional cost incurred by  producing one more unit of that good or service. ∙ Marginal cost = the summation of sequential units Production of a good or service has increasing marginal cost when each  additional unit costs more to produce than the previous one. Total Cost equals the summation of sequential marginal costs. ∙ Total cost increases whenever marginal cost is positive; regardless of  whether marginal cost is increasing or decreasing. ∙ Total cost and marginal cost don’t always move in the same direction The marginal cost curve shows how the cost of producing one more unit depends  on the quantity that has already been produced.Production of a good or service has constant marginal cost when each additional  unit costs the same to produce as the previous one. ∙ The marginal cost curve is horizontal Production of a good or service has decreasing marginal cost when each  additional unit costs less to produce than the previous one. ∙ Occurs due to learning curves during production The marginal benefit of a good or service is the additional benefit derived from  producing one more unit of that good or service. There is decreasing marginal benefit from an activity when each additional unit  of the activity yields less benefit than the previous unit. The marginal benefit curve shows how the benefit from producing one more unit  depends on the quantity that has already been produced. The optimal quantity is the quantity that generates the highest possible total  profit. With small quantities, the rule for choosing the optimal quantity is: increase the  quantity as long as the marginal benefit from one more unit is greater than the  marginal cost, but stop before the marginal benefit becomes less than the  marginal cost.In contrast, when a “how much” decision involves relatively large quantities, the  rule for choosing the optimal quantity simplifies to this: The optimal quantity is  the quantity at which marginal benefit is equal to marginal cost. Profit-maximizing principle of marginal analysis: When making a profit maximizing “how much” decision, the optimal quantity is the largest quantity at  which marginal benefit is greater than or equal to marginal cost. Making Decisions Using Marginal Analysis The “how much”  decision to be  made The retaiiler  Applying marginal analysis Arriving at the optimal  quantity PalMart must compare the  marginal benefit of enlarging the  PalMart must  decide on the size  of the new store it  is constructing in  Beijing. A physician must  decide whether or  not to increase the  dosage of a drug in  light of possible  side effects. store by 1 square foot (the value  of the additional sales it makes  from that additional square foot  of floor space) to the marginal  cost (the cost of constructing and  maintaining the additional square  foot). The physician must consider the  marginal cost, in terms of side  effects, of increasing the dosage  of a drug versus the marginal  benefit of improving health by  increasing the dosage. The optimal store size for  PalMart is the largest size  at which marginal benefit is  greater than or equal to  marginal cost. The optimal dosage level is  the largest level at which  the marginal benefit of  disease amelioration is  greater than or equal to the  marginal cost of side  effects.A farmer must  decide how much  fertilizer to apply. More fertilizer increases crop  yield but also costs more. The optimal amount of  fertilizer is the largest  quantity at which the marginal benefit of higher  crop yield is greater than or  equal to the marginal cost  of purchasing and applying  more fertilizer. ∙ A “how much” decision is made by using marginal analysis. ∙ The marginal cost of producing a good or service is represented graphically by  the marginal cost curve. An upward-sloping marginal cost curve reflects  increasing marginal cost. Constant marginal cost is represented by a  horizontal marginal cost curve. A downward-sloping marginal cost curve  reflects decreasing marginal cost. ∙ The marginal benefit of producing a good or service is represented by the  marginal benefit curve. A downward-sloping marginal benefit curve reflects  decreasing marginal benefit. ∙ The optimal quantity, the quantity which generates the highest possible total  profit, is found by applying the profit-maximizing principle of marginal  analysis, according to which the optimal quantity is the largest quantity at  which marginal benefit is greater than or equal to marginal cost. Graphically, it  is the quantity at which the marginal cost curve intersects the marginal benefit  curve. A sunk cost is a cost that has already been incurred and is non-recoverable. A  sunk cost should be ignored in decisions about future actions. Sunk costs should be ignored in decisions regarding future actions. Because they  have already been incurred and are non-recoverable, they have no effect on  future costs and benefits.Rational Decision Making A rational decision maker chooses the available option that leads to the outcome  he or she most prefers: Three principle reasons why people may prefer a worse  economic payoff: Concerns about fairness, bounded rationality & risk aversion. 1. Concerns about fairness ∙ Leaving a tip ∙ Giving a birthday of Christmas present 2. A decision maker operating with bounded rationality makes a choice that is  close to but not exactly the one that leads to the best possible economic  outcome. ∙ “Good enough” ~ when only a limit of effort is put into a decision ∙ Anchoring ~ making a decision based upon some perceived  benchmark or reference point 3. Risk aversion is the willingness to sacrifice some economic payoff in order  to avoid a potential loss. ∙ Buying an insurance policy Irrational Decision Making 1. Misperceiving opportunity costs 2. Being overconfident 3. Having unrealistic expectations about future behavior 4. Counting dollars unequally 5. Being loss-averse6. Having a bias toward the status quo An irrational decision maker chooses an option that leaves him or her worse off  than choosing another available option. Misperception of opportunity costs ∙ Not taking into account implicit (nonmonetary) opportunity costs ∙ Using and counting in “sunk costs” Overconfidence ∙ A function of ego ∙ Remember successes & forget or explain away failures Unrealistic expectations about future behavior ~ another form of overconfidence  is being optimistic about your future behavior by ignoring strategies that keep a  person on the straight and narrow over time. ∙ Automatic payroll deductions for a retirement plan ∙ Diet plans with prepackaged foods ∙ Mandatory attendance at study groups Mental accounting is the habit of mentally assigning dollars to different accounts  so that some dollars are worth more than others. ∙ Overspending or using credit cardsLoss aversion is an oversensitivity to loss, leading to unwillingness to recognize a  loss and move on. ∙ Avoiding the sale of a losing stock ~ lack of “selling discipline” The status quo bias is the tendency to avoid making a decision and sticking with  the status quo. ∙ Opt-in & Opt-out employee savings plans ∙ Behavioral economics combines economic modeling with insights from human  psychology. ∙ Rational behavior leads to the outcome a person most prefers. Bounded  rationality, risk aversion, and concerns about fairness are reasons why people  might prefer outcomes with worse economic payoffs. ∙ Irrational behavior occurs because of misperceptions of opportunity costs,  overconfidence, mental accounting, and unrealistic expectations about the  future. Loss aversion and status quo bias can also lead to choices that leave  people worse off than they would be if they chose another available option. 1. All economic decisions involve the allocation of scarce resources. Some  decisions are “either–or” decisions, in which the question is whether or not to  do something. Other decisions are “how much” decisions, in which the question  is how much of a resource to put into a given activity. 2. The cost of using a resource for a particular activity is the opportunity cost of  that resource. Some opportunity costs are explicit costs; they involve a direct  outlay of money. Other opportunity costs, however, are implicit costs; they  involve no outlay of money but are measured by the dollar value of the benefits  that are forgone. Both explicit and implicit costs should be taken into account in  making decisions. Many decisions involve the use of capital and time, for both  individuals and firms. So they should base decisions on economic profit, which  takes into account implicit costs such as the opportunity cost of time and the  implicit cost of capital. Making decisions based on accounting profit can be misleading. It is often considerably larger than the economic profit because it  includes only explicit costs and not implicit costs. 3. According to the principle of “either–or” decision making, when faced with  an “either–or” choice between two activities, one should choose the activity  with the positive economic profit. 4. A “how much” decision is made using marginal analysis, which involves  comparing the benefit to the cost of doing an additional unit of an activity. The  marginal cost of producing a good or service is the additional cost incurred by  producing one more unit of that good or service. The marginal benefit of  producing a good or service is the additional benefit earned by producing one  more unit. The marginal cost curve is the graphical illustration of marginal  cost, and the marginal benefit curve is the graphical illustration of marginal  benefit. 5. In the case of constant marginal cost, each additional unit costs the same  amount to produce as the previous unit. However, marginal cost and marginal  benefit typically depend on how much of the activity has already been done.  With increasing marginal cost, each unit costs more to produce than the  previous unit and is represented by an upward-sloping marginal cost curve.  With decreasing marginal cost, each unit costs less to produce than the  previous unit, leading to a downward-sloping marginal cost curve. In the case  of decreasing marginal benefit, each additional unit produces a smaller benefit  than the unit before. 6. The optimal quantity is the quantity that generates the highest possible total  profit. According to the profit-maximizing principle of marginal analysis, the  optimal quantity is the quantity at which marginal benefit is greater than or  equal to marginal cost. It is the quantity at which the marginal cost curve and  the marginal benefit curve intersect. 7. A cost that has already been incurred and that is non-recoverable is a sunk cost.  Sunk costs should be ignored in decisions about future actions because they  have no effect on future benefits and costs. 8. With rational behavior, individuals will choose the available option that leads  to the outcome they most prefer. Bounded rationality occurs because the effort  needed to find the best economic payoff is costly. Risk aversion causes  individuals to sacrifice some economic payoff in order to avoid a potential loss.  People might also prefer outcomes with worse economic payoffs because they  are concerned about fairness. 9. An irrational choice leaves someone worse off than if they had chosen another  available option. It takes the form of misperceptions of opportunity cost;  overconfidence; unrealistic expectations about future behavior; mental  accounting, in which dollars are valued unequally; loss aversion, an oversensitivity to loss; and status quo bias, avoiding a decision by sticking  with the status quo. Correct Matches: ➜ Explicit cost a cost that requires an outlay of money. ➜ Implicit cost ➜ a cost that does not require the outlay of money; it is measured by the  value, in dollar terms, of forgone benefits. Accounting profit revenue minus explicit cost. ➜ Economic profit ➜ Capital ➜ Implicit cost of capital ➜ Principle of “either–or”  decision making ➜ Marginal cost ➜ Increasing marginal  cost revenue minus the opportunity cost of resources used; usually less than  the accounting profit. the total value of assets owned by an individual or firm—physical  assets plus financial assets. the opportunity cost of the use of one’s own capital— the income  earned if the capital had been employed in its next best alternative use. the principle that, in a decision between two activities, the one with the  positive economic profit should be chosen. the additional cost incurred by producing one more unit of a good or  service. each additional unit costs more to produce than the previous one.➜ Marginal cost curve ➜ a graphical representation showing how the cost of producing one more  unit depends on the quantity that has already been produced. Constant marginal cost each additional unit costs the same to produce as the previous one. ➜ Decreasing marginal  cost ➜ Marginal benefit ➜ Decreasing marginal  benefit ➜ Marginal benefit curve ➜ each additional unit costs less to produce than the previous one. the additional benefit derived from producing one more unit of a good  or service. each additional unit of an activity yields less benefit than the previous  unit. a graphical representation showing how the benefit from producing one  more unit depends on the quantity that has already been produced. Optimal quantity the quantity that generates the highest possible total net gain. ➜ Profit-maximizing  principle of marginal  analysis ➜ the proposition that in a profit-maximizing “how much ” decision the  optimal quantity is the largest quantity at which marginal benefit is  greater than or equal to marginal cost. Sunk cost a cost that has already been incurred and is not recoverable. ➜ Rational ➜ Bounded rationality describes a decision maker who chooses the available option that leads  to the outcome he or she most prefers. a basis for decision making that leads to a choice that is close to but not  exactly the one that leads to the best possible economic outcome; the  “good enough ” method of decision making. ➜the willingness to sacrifice some economic payoff in order to avoid a  potential loss.Risk aversion ➜ Irrational ➜ Mental accounting ➜ Loss aversion ➜ describes a decision maker who chooses an option that leaves him or  her worse off than choosing another available option. the habit of mentally assigning dollars to different accounts so that  some dollars are worth more than others. oversensitivity to loss, leading to unwillingness to recognize a loss and  move on. Status quo bias the tendency to avoid making a decision.

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