The Average-Marginal Distinction The importance of acting on marginal costs and benefits in economic decision making cannot be overstated.
This notion is a bit slippery the first time it is considered, but is extremely important in the decision
making process. We tend to think in terms of averages when considering costs and benefits. We must train
ourselves to consider the additional, (or marginal in economic terms) not the average costs and benefits
of our choices if we want to make better decisions. Exploration: How does the consideration of Marginal costs and benefits keep us focused on the relevant
costs and benefits in a decision? Chapter 1, problem 2 looks at the concept of marginal cost and marginal benefit by asking how many pounds of compost
you should use on your tomato patch to generate the highest possible amount of profit. How can we transform the
example, which is presented in table form, into a graphical form that will allow us to quickly determine the answer
to this question? The table above shows how tomato production changes as the amount of compost applied changes. The box below the
table provides information on the prices of compost and tomatoes and an adjustment slider for productivity. For
this example, the marginal cost of compost is fixed, at the price of compost. In addition, the marginal benefit
and cost information is presented graphically. You can change the price of compost and the price of tomatoes and
both the tables and the graph will respond accordingly. Try a quick change in the price of tomatoes, to $0.30 and
observe the new values in the table and the new Marginal Benefit curve. Once you are comfortable with how the graph
works, click the Reset button to return to the original settings. This setting is for a mythical student named Heather,
so let's use her case as the example. | 1. |
Use the graph to determine how much compost Heather should use on her tomatoes, based on the information presented.
Explain how you arrived at your answer.
| | 2. |
Verify that your answer to the question above is correct. That is, show that the highest level of profits occurs at the quantity of compost you selected. To do this, on a piece of paper copy the first two columns of the table above (the compost and tomato production information) and for each quantity of compost added, determine the total cost of the compost used, the total revenue generated from the resulting tomato production, and the amount of profit (total cost – total revenue). Which level of compost use leads to the highest profit? How is this analysis using total costs and total revenue related to your analysis using marginal costs and marginal benefits?
| | 3. |
How much compost will Heather add to her tomato garden if the price of compost falls to $.75 per pound (keeping the price of tomatoes at $.20 per pound)? To begin, change the compost price in the table above and notice how the table and graph changes. Then determine the amount of compost Heather will use if her goal is to make as much money as possible. Compare this amount to your original answer. Did it increase or decrease? Why?
| | 4. |
How much compost will Heather add to her tomato garden if instead the price of tomatoes rises to $.40 per pound, while the price of compost remains at its original level of $1.40 per pound? To begin, click the Reset button to reset the original values in the table above. Next, change the price of tomatoes in the table to $.40 and notice how the table values and graph change. Then determine the amount of compost Heather will use if her goal is to make as much money as possible. Compare this amount to your original answer. Did it increase or decrease? Why?
| | 5. |
What if Heather takes a gardening class that teaches her better tomato growing techniques (weeding, watering, pruning tips, for example) that lead to a dramatic increase in tomato production? For example, if Heather can now produce 100% more tomatoes for any given level of compost, how will this affect the amount compost Heather uses, if her goal is to make as much money as possible?
To begin, click the Reset button to reset the original values in the table above. Next, slide the productivity index to 100%. See how the values in the table change. | | 6. |
As an extension of this idea, what if Heather could buy compost in units smaller than one pound?
| | | | | View Answers |
Exercise picked up from the 2e Microeconomics textbook. |
