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much should be used to defend Germanys




3/17/05;5:55 PM;chapter;500_12489_CH07_170-191;7;Page 170;Making;Decisions;A T A L E O F T W O I N VA S I O N S;O;6, 1944, ALLIED SOLDIERS;much should be used to defend Germanys;stormed the beaches of Norman-;border with France? The original plan;dy, beginning the liberation of;devised by General Alfred von Schlieffen;France from German rule. Long before the;allocated most of the German army to the;assault, however, Allied generals had to;invasion force, on his deathbed, Schlieffen is;make a crucial decision: where would the;supposed to have pleaded, Keep the right;soldiers land?;wing [the invasion force] strong! But his;N JUNE;How economists model decision;making by individuals and firms;The importance of implicit as;well as explicit costs in decision;making;The difference between accounting profit and economic profit;and why economic profit is the;correct basis for decisions;The difference between;eitheror and how much;decisions;The principle of marginal;analysis;eitheror decision. Either the invasion;weakened the plan: he reallocated some of;force could cross the English Channel at its;the divisions that were supposed to race;through Belgium to the defence. The weak-;the Germans expectedor it could try to;ened invasion force wasnt strong enough;surprise the Germans by;landing farther west, in;Normandy. Since men and;landing craft were in limited supply, the Allies could;not do both. In fact, they;chose to rely on surprise.;The German defences in;Normandy were too weak to;stop the landings, and the;MGM/The Kobal Collection;successor, General Helmuth von Moltke;narrowest point, Calaiswhich was what;What you will learn in;this chapter;They had to make what we call an;Allies went on to liberate;France and win the war.;Thirty years earlier, at the;beginning of World War I;Decision: Attack here? Or there?;What sunk costs are and why;they should be ignored;German generals had to;make a different kind of decision. They, too;the defending French army stopped it 30;How to make decisions in cases;where time is a factor;planned to invade France, in this case via;miles from Paris. Most military historians;land, and had decided to mount that invasion;believe that by allocating too few men to the;through Belgium. The decision they had to;attack, von Moltke cost Germany the war.;make was not an eitheror but a how much;decision: how much of their army should be;170;So Allied generals made the right decision in 1944, German generals made the;allocated to the invasion force, and how;wrong decision in 1914. The important;500_12489_CH07_170-191;3/17/05;5:55 PM;Page 171;point for this chapter is that in both cases;at the significance of opportunity cost for;the generals had to apply the same logic;economic decisions and the role it plays in;that applies to economic decisions, like;eitheror decisions. Next we turn to the;production decisions by businesses and;problem of making how much decisions;consumption decisions by households.;and the usefulness of marginal analysis. We;In this chapter we will survey the princi-;then examine what kind of costs should be;ples involved in making economic deci-;ignored in making a decisioncosts which;sions. These principles will help us under-;economists call sunk costs. We end by con-;stand how any individualwhether a con-;sidering the concept of present value and its;sumer or a producermakes an economic;importance for making decisions when;decision. We begin by taking a deeper look;costs and benefits arrive at different times.;Opportunity Cost And Decisions;In Chapter 1 we introduced some core principles underlying economic decisions.;Weve just seen two of those principles at work in our tale of two invasions. The first;is that resources are scarcethe invading Allies had a limited number of landing craft;and the invading Germans had a limited number of divisions. Because resources are;scarce, the true cost of anything is its opportunity costthat is, the real cost of something is what you must give up to get it. When it comes to making decisions, it is crucial to think in terms of opportunity cost, because the opportunity cost of an action;is often considerably more than the simple monetary cost.;Explicit versus Implicit Costs;Suppose that, upon graduation from university, you have two options: to go to school;for an additional year to get an advanced degree or to take a job immediately. You;would like to take the extra year in school but are concerned about the cost.;But what exactly is the cost of that additional year of school? Here is where it is;important to remember the concept of opportunity cost: the cost of that year spent;getting an advanced degree is what you forgo by not taking a job for that year.;This cost, like any cost, can be broken into two parts: the explicit cost of the years;schooling and the implicit cost.;An explicit cost is a cost that requires an outlay of money. For example, the;explicit cost of the additional year of schooling includes tuition. An implicit cost;on the other hand, does not involve an outlay of money, instead, it is measured by;the value, in dollar terms, of all the benefits that are forgone. For example, the;implicit cost of the year spent in school includes the income you would have earned;if you had taken that job instead.;A common mistake, both in economic analysis and in real business situations, is to;ignore implicit costs and focus exclusively on explicit costs. But often the implicit cost of;an activity is quite substantialindeed, sometimes it is much larger than the explicit cost.;Table 7-1 gives a breakdown of hypothetical explicit and implicit costs associated;with spending an additional year in school instead of taking a job. The explicit cost;consists of tuition, books, supplies, and a home computer for doing assignmentsall;of which require you to spend money. The implicit cost is the salary you would have;earned if you had taken a job instead. As you can see, the forgone salary is $35,000;and the explicit cost is $9,500, making the implicit cost more than three times as;much as the explicit cost. So ignoring the implicit cost of an action can lead to a seriously misguided decision.;An explicit cost is a cost that involves;actually laying out money. An implicit;cost does not require an outlay of;money, it is measured by the value, in;dollar terms, of the benefits that are;forgone.;171;500_12489_CH07_170-191;172;PA R T 1;3/17/05;5:55 PM;Page 172;W H AT I S E C O N O M I C S?;TABLE;7-1;Opportunity Cost of an Additional Year of School;Explicit cost;Tuition;Implicit cost;$7,000;Books and supplies;Home computer;Total implicit cost;9,500;$35,000;35,000;1,500;Total explicit cost;Forgone salary;1,000;Total opportunity cost = Total explicit cost + Total implicit cost = $44,500;There is another, slightly different way of looking at the implicit cost in this example that can deepen our understanding of opportunity cost. The forgone salary is the;cost of using your own resourcesyour timein going to school rather than working.;The use of your time for more schooling, despite the fact that you dont have to spend;any money, is nonetheless costly to you. This illustrates an important aspect of opportunity cost: in considering the cost of an activity, you should include the cost of using;any of your own resources for that activity. You can calculate the cost of using your;own resources by determining what they would have earned in their next best use.;FOR;INQUIRING;MINDS;FAMOUS COLLEGE DROPOUTS;What do Bill Gates, Tiger Woods, and Sarah;Michelle Gellar (a.k.a. Buffy the Vampire;Slayer) have in common? None of them have a;college degree.;Nobody doubts that all three are easily smart;enough to have gotten their diplomas.;However, they all made the rational decision;that the implicit cost of getting a degree;would have been too highby their late teens;each had a very promising career that would;have had to be put on hold to get a college;degree. Gellar would have had to postpone her;acting career, Woods would have had to put off;winning one major tournament after another;and becoming the worlds best golfer, Gates;would have had to delay developing the most;successful and most lucrative software ever;sold, Microsofts computer operating system.;In fact, extremely successful peopleespecially those in careers like acting or athletics;where starting early in life is especially crucialare often college dropouts. Its a simple;matter of economics: the opportunity cost of;their time at that stage in their lives is just;too high to postpone their careers for a college degree.;Accounting Profit versus Economic Profit;As the example of going to school suggests, taking account of implicit as well as;explicit costs can be very important for individuals making decisions. The same is true;of businesses.;Consider the case of Kathys Copy Shop, a small business operating in a local shopping centre. Kathy makes copies for customers, who pay for her services. Out of that;revenue, she has to pay her expenses: the cost of supplies and the rent for her store;space. We suppose that Kathy owns the copy machines themselves. This year Kathy;has $100,000 in revenues and $60,000 in expenses. Is her business profitable?;At first it might seem that the answer is obviously yes: she receives $100,000 from;her customers and has expenses of only $60,000. Doesnt this mean that she has a;profit of $40,000? Not according to her accountant, who reduces the number by;$5,000, for the yearly depreciation (reduction in value) of the copy machines.;500_12489_CH07_170-191;3/17/05;5:55 PM;Page 173;CHAPTER 7;Depreciation occurs because machines wear out over time. The yearly depreciation;amount reflects what an accountant estimates to be the reduction in the value of the;machines due to wear and tear that year. This leaves $35,000, which is the businesss;accounting profit. Basically, the accounting profit of a company is its revenue;minus its explicit costs and depreciation. The accounting profit is the number that;Kathy has to report on her income tax forms and that she would be obliged to report;to anyone thinking of investing in her business.;Accounting profit is a very useful number, but suppose that Kathy wants to decide;whether to keep her business going or to do something else. To make this decision;she will need to calculate her economic profitthe revenue she receives minus her;opportunity cost, which may include implicit as well as explicit costs. In general;when economists use the simple term profit, they are referring to economic profit.;(We will adopt this simplification in later chapters of this book.);Why does Kathys economic profit differ from her accounting profit? Because she;may have implicit costs over and above the explicit cost her accountant has calculated. Businesses can face implicit costs for two reasons. First, a businesss capitalits;equipment, buildings, tools, inventory, and financial assetscould have been put to;use in some other way. If the business owns its capital, it does not pay any money for;its use, but it pays an implicit cost because it does not use the capital in some other;way. Second, the owner devotes time and energy to the business that could have been;used elsewherea particularly important factor in small businesses, whose owners;tend to put in many long hours.;If Kathy had rented her copy machines from the manufacturer, their rent would;have been an explicit cost. But because Kathy owns her own machines, she does not;pay rent on them and her accountant deducts an estimate of their depreciation in the;profit statement. However, this does not account for the opportunity cost of the;machineswhat Kathy forgoes by owning them. Suppose that instead of using the;machines for her own business, the best alternative Kathy has is to sell them for;$50,000 and put the money into a bank account where it would earn yearly interest;of $3,000. This $3,000 is an implicit cost of running the business.;It is generally known as the implicit cost of capital, the opportunity cost of the;capital used by a business, it reflects the income that could have been realized if the;capital had been used in its next best alternative way. It is just as much a true cost as;if Kathy had rented the machines instead of owning them.;Finally, Kathy should take into account the opportunity cost of her own time.;Suppose that instead of running her own shop, she could earn $34,000 as an office;manager. That $34,000 is also an implicit cost of her business.;Table 7-2 summarizes the accounting for Kathys Copy Shop, taking both explicit;and implicit costs into account. It turns out, unfortunately, that although the business makes an accounting profit of $35,000, its economic profit is actually negative.;TABLE;7-2;Profits at Kathys Copy Shop;Revenue;$100,000;Explicit cost;60,000;Depreciation;5,000;Accounting profit;35,000;Implicit cost of business;Income Kathy could have earned on capital in the next best way;Income Kathy could have earned as manager;Economic profit;3,000;34,000;2,000;MAKING DECISIONS;173;The accounting profit of a business is;the businesss revenue minus the;explicit cost and depreciation.;The economic profit of a business is the;businesss revenue minus the opportunity cost of its resources. It is usually less;than the accounting profit.;The capital of a business is the value of;its assetsequipment, buildings, tools;inventory, and financial assets.;The implicit cost of capital is the;opportunity cost of the capital used by a;businessthe income the owner could;have realized from that capital if it had;been used in its next best alternative;way.;500_12489_CH07_170-191;The New Yorker Collection. 2000 William Hamilton from;All Rights Reserved;174;PA R T 1;3/17/05;5:55 PM;Page 174;W H AT I S E C O N O M I C S?;This means that Kathy would be better off financially if she closed the;business and devoted her time and capital to something else.;In real life, discrepancies between accounting profits and economic profits are extremely common. As the following Economics in;Action explains, this is a message that has found a receptive audience;among real-world businesses.;economics in action;Urban Sprawl and the Loss of Farmland in Canada;It seems irrational that some of the most fertile agricultural land in;Canada is buried under concrete and tarmaca victim of urban sprawl.;Why does this occur and what, if anything, can be done about it?;Ive done the numbers, and I will marry you.;The root cause is simple enough. Historically, people congregated in;fertile areas, and villages and cities grew up in the middle of the most;productive land, especially if there were also water routes nearby that facilitated trading.;Given these beginnings, city growth almost inevitably absorbs some of the best farmland.;The mechanics of urban growth work like this. As land prices increase on the edge of;an urban area, so the implicit cost of farming increases. It doesnt matter whether the;farmer owns the land or not. Because land is a form of capital used to run the business;keeping ones land as a farm instead of selling it to a developer constitutes an implicit;cost of capital. Higher land prices increase the implicit cost of capital, which raises the;cost of farmingeven if the farmer owns the land. This puts intense pressure on farmers;to generate incomes that are substantial enough to justify keeping the land in agriculture.;Eventually, these pressures become too great and the land is sold for development.;How great are these pressures? Well, farmland in Canada can sell for anything;from $100 to $100,000 an acre, depending on its quality and location. Around small;urban centres, one would expect to pay about $7000 an acre for good farmland in;2004, depending on the province. But around large metropolitan areas, prices are;much higher. For example, a farm within 30 miles of the greater Toronto area, where;urban development is foreseeable within the next 5 to 10 years, would command;prices of about $100,000 an acre. Its nearly impossible to operate a farm with such;a high implicit cost of capital. Thats why developers succeed in buying up land where;development is foreseen many years before the development takes place. They buy it;and hold it as an investmenta so-called land bank.;Before we get too alarmed about urban sprawl, we should note that urban areas do;need space to grow. We should be happy weve got it. Moreover, we should bear in mind;that much of the decrease in the amount of land devoted to farming over the last 100;years has nothing to do with the growth of urban centres. Rather, it is due to the replacement of the horse with the tractor as the primary farm vehicle, which reduced the amount;of land needed to produce hay and led to the abandonment of much pastureland.;Nevertheless, all provinces feel the need to control urban sprawl in various ways.;Most attempt to do this through zoning regulations and urban plans created by the;municipality or local service district. The big drawback with this approach is that;farmers comprise only about 3% of the rural population, so rural zoning laws may;not offer much effective protection against urban development. Partly as a result of;this problem, British Columbia set up an Agricultural Land Reserve in the 1970s. In;essence, this took zoning decisions out of local hands and put them under provincial;jurisdiction, and it has been very effective in preventing urban sprawl around southwestern BC and the Okanagan Valley.;But there are other options for controlling urban sprawl. For example, New;Brunswick has a farmland identification program under which provincial property;taxes can be deferred indefinitely while the land remains farmland, but should the;land be abandoned or developed, the last 15 years worth of property taxes (plus;500_12489_CH07_170-191;3/17/05;5:55 PM;Page 175;MAKING DECISIONS;CHAPTER 7;accrued interest) becomes due immediately. Another method, more common in the;U.S. than Canada, is to sell the development rights to a trust. Any developer must;then not only buy the land from the farmer but also must buy the development rights;from the trust. This insulates the farmer against increases in the implicit cost of capital due to higher land prices caused by impending development. Moreover, farmers;benefit from the money they receive from selling the development rights to the land;trust, but can meanwhile continue to use the land for agriculture.;So, the main point is two-pronged: first, high implicit costs of capital put enormous;pressure on farmers to sell their land to urban developers, and second, attempts to;contain this pressure use zoning, farmland identification programs, and land trusts.;CHECK YOUR UNDERSTANDING 7-1;Karma and Don run a furniture-refinishing business from their home. Which of the following represent an explicit cost of the business and which represent an implicit cost?;a. Supplies such as paint stripper, varnish, polish, sandpaper, and so on;b. Basement space that has been converted into a workroom;c. Wages paid to a part-time helper;d. A van that they inherited and use only for transporting furniture;e. The job at a larger furniture restorer that Karma gave up in order to run the business;Solutions appear at back of book.;Making How Much Decisions;The Role Of Marginal Analysis;As the story of the two wars at the beginning of this chapter demonstrated, there are two;types of decisions: eitheror decisions and how much decisions. To help you get a;better sense of that distinction, Table 7-3 offers some examples of each kind of decision.;TABLE;7-3;How Much versus EitherOr Decisions;How much decisions;Eitheror decisions;How many days before you do your laundry?;Tide or Cheer?;How many miles do you go before an oil;change in your car?;Buy a car or not?;How many jalapenos on your nachos?;An order of nachos or a sandwich?;How many workers should you hire in your company?;Run your own business;or work for someone else?;How much should a patient take of a drug;that generates side effects?;Prescribe drug A or;drug B for your patients?;How many troops do you allocate to your invasion force?;Invade at Calais or in Normandy?;Although many decisions in economics are eitheror, many others are how;much. Not many people will stop driving if the price of gasoline goes up, but many;people will drive less. How much less? A rise in wheat prices wont necessarily persuade a lot of people to take up farming for the first time, but it will persuade farmers who were already growing wheat to plant more. How much more?;To understand how much decisions, we use an approach known as marginal;analysis. Marginal analysis involves comparing the benefit of doing a little bit more;of some activity with the cost of doing a little bit more of that activity. The benefit of;doing a little bit more of something is what economists call its marginal benefit, and;the cost of doing a little bit more of something is what they call its marginal cost.;175;QUICK REVIEW;All costs are opportunity costs.;They can be divided into explicit;costs and implicit costs.;Companies report their accounting;profit, which is not necessarily;equal to their economic profit.;Due to the implicit cost of capital;the opportunity cost of a companys;capital, and the opportunity cost of;the owners time, economic profit is;often substantially less than;accounting profit.;500_12489_CH07_170-191;176;PA R T 1;3/17/05;5:55 PM;Page 176;W H AT I S E C O N O M I C S?;Why is this called marginal analysis? A margin is an edge, what you do in marginal analysis is push out the edge a bit, and see whether that is a good move.;We will begin our study of marginal analysis by focusing on marginal cost, and;well do that by considering a hypothetical company called Felixs Lawn-mowing;Service, operated by Felix himself with his tractor-mower.;Marginal Cost;Felix is a very hardworking individual, if he works continuously, he can mow 7 lawns;in a day. It takes him an hour to mow each lawn. The opportunity cost of an hour of;Felixs time is $10.00 because he could make that much in his next best job.;His one and only mower, however, presents a problem when Felix works this hard.;Running his mower for longer and longer periods on a given day takes an increasing;toll on the engine and ultimately necessitates moreand more costlymaintenance;and repairs.;The second column of Table 7-4 shows how the total daily cost of Felixs business;depends on the quantity of lawns he mows in a day. For simplicity, we assume that Felixs;only costs are the opportunity cost of his time and the cost of upkeep for his mower.;TABLE;7-4;Felixs Marginal Cost of Mowing Lawns;Quantity of;lawns mowed;Felixs;total cost;0;$0;1;10.50;2;21.75;3;35.00;4;50.50;5;68.50;6;89.25;7;Felixs marginal cost;of lawn mowed;$113.00;$10.50;11.25;13.25;15.50;18.00;20.75;23.75;The marginal cost of an activity is the;additional cost incurred by doing one;more unit of that activity.;There is increasing marginal cost from;an activity when each additional unit of;the activity costs more than the previous unit.;At only 1 lawn per day, Felixs daily cost is $10.50: $10.00 for an hour of his time;plus $0.50 for some oil. At 2 lawns per day, his daily cost is $21.75: $20 for 2 hours;of his time and $1.75 for mower repair and maintenance. At 3 lawns per day, the;daily cost has risen to $35.00: $30.00 for 3 hours of his time and $5.00 for mower;repair and maintenance.;The third column of Table 7-4 contains the cost incurred by Felix for each additional lawn he mows, calculated from information in the second column. The 1st;lawn he mows costs him $10.50, this number appears in the third column between;the lines representing 0 lawn and 1 lawn because $10.50 is Felixs cost of going from;0 to 1 lawn mowed. The next lawn, going from 1 to 2, costs him an additional $11.25.;So $11.25 appears in the third column between the lines representing the 1st and 2nd;lawn, and so on.;The increase in Felixs cost when he mows one more lawn is his marginal cost of;lawn-mowing. In general, the marginal cost of any activity is the additional cost;incurred by doing one more unit of that activity.;The marginal costs shown in Table 7-4 have a clear pattern: Felixs marginal cost;is greater the more lawns he has already mowed. That is, each time he mows a lawn;the additional cost of doing yet another lawn goes up. Felixs lawn-mowing business;has what economists call increasing marginal cost: each additional lawn costs;500_12489_CH07_170-191;3/17/05;5:55 PM;Page 177;CHAPTER 7;Figure;MAKING DECISIONS;177;7-1;The Marginal Cost Curve;The height of each bar is equal to the marginal;cost of mowing the corresponding lawn. For example, the 1st lawn mowed has a marginal cost of;$10.50, equal to the height of the bar extending;from 0 to 1 lawn. The bars ascend in height;reflecting increasing marginal cost: each additional;lawn is more costly to mow than the previous one.;As a result, the marginal cost curve (drawn by;plotting points in the top center of each bar) is;upward sloping.;Marginal;cost of;lawn mowed;$35;30;Marginal cost, MC;25;20;15;10;5;0;1;2;3;4;5;6;7;Quantity of lawns mowed;more to mow than the previous one. Or, to put it slightly differently, with increasing;marginal cost, the marginal cost of an activity rises as the quantity already done rises.;Figure 7-1 is a graphical representation of the third column in Table 7-4. The horizontal axis measures the quantity of lawns mowed, and the vertical axis measures the;marginal cost of a mowed lawn. The height of each shaded bar represents the marginal cost incurred by mowing a given lawn. For example, the bar stretching from 4 to 5;lawns is at a height of $18.00, equal to the cost of mowing the 5th lawn. Notice that;the bars form a series of ascending steps, a reflection of the increasing marginal cost of;lawn mowing. The marginal cost curve, the red curve in Figure 7-1, shows the relaThe marginal cost curve shows how the;cost of undertaking one more unit of an;tionship between marginal cost and the quantity of the activity already done. We draw;activity depends on the quantity of that;it by plotting a point in the center at the top of each bar and connecting the points.;activity that has already been done.;The marginal cost curve is upward sloping, due to increasing marginal cost. Not;all activities have increasing marginal cost, for example, it is possible for marginal;cost to be the same regardless of the number of lawns already;mowed. Economists call this case constant marginal cost. It is;PITFALLS;also possible for some activities to have a marginal cost that;initially falls as we do more of the activity and then eventualincreasing total cost versus increasing;ly rises. These sorts of activities involve gains from specializamarginal cost;tion: as more output is produced, more workers are hired;The concept of increasing marginal cost plays an important;allowing each one to specialize in the task that he or she perrole in economic analysis, but students sometimes get conforms best. The gains from specialization yield a lower marfused about what it means. Thats because it is easy to;wrongly conclude that whenever total cost is increasing;ginal cost of production.;marginal cost must also be increasing. But the following;Now that we have established the concept of marginal cost;example shows that this conclusion is misguided.;we move to the parallel concept of marginal benefit.;Marginal Benefit;Felixs business is in a town where some of the residents are;very busy but others are not so busy. For people who are very;busy, the opportunity cost of an hour of their time spent;mowing the lawn is very high. So they are willing to pay Felix;a fairly high sum to do it for them. People with lots of free;time, however, have a lower opportunity cost of an hour of;their time spent mowing the lawn. So they are willing to pay;Suppose that we change the numbers of our example;the marginal cost of mowing the 6th lawn is now $20, and;the marginal cost of mowing the 7th lawn is now $15. In;both instances total cost increases as Felix does an additional lawn: it increases by $20 for the 6th lawn and by $15;for the 7th lawn. But in this example marginal cost is;decreasing: the marginal cost of the 7th lawn is less than;the marginal cost of the 6th lawn. So we have a case of;increasing total cost and decreasing marginal cost. What;this shows us is that, in fact, totals and marginals can;sometimes move in opposite directions.;500_12489_CH07_170-191;178;PA R T 1;3/17/05;5:55 PM;Page 178;W H AT I S E C O N O M I C S?;The marginal benefit from an activity is;the additional benefit derived from;undertaking one more unit of that;activity.;Felix only a relatively small sum. And between these two extremes lie other residents;who are moderately busy and so are willing to pay a moderate price to have their;lawns mowed.;Well assume that on any given day, Felix has one potential customer who will pay;him $35 to mow her lawn, another who will pay $30, a third who will pay $26, a;fourth who will pay $23, and so on. Table 7-5 lists what he can receive from each of;his seven potential customers per day, in descending order according to price. So if;Felix goes from 0 to 1 lawn mowed, he can earn $35, if he goes from 1 to 2 lawns;mowed, he can earn an additional $30, and so on. The third column of Table 7-5;shows us the marginal benefit to Felix of each additional lawn mowed. In general;marginal benefit is the additional benefit derived from undertaking one more unit of;an activity. Because it arises from doing one more lawn, each marginal benefit value;appears between the lines associated with successive quantities of lawns.;TABLE;7-5;Felixs Marginal Benefit of Mowing Lawns;Quantity of;lawns mowed;Felixs;total benefit;0;$0;1;35.00;2;65.00;3;91.00;4;114.00;5;135.00;6;154.00;7;Felixs marginal benefit;of lawn mowed;$172.00;$35.00;30.00;26.00;23.00;21.00;19.00;18.00;There is decreasing marginal benefit;from an activity when each additional;unit of the activity produces less benefit;than the previous unit.;The marginal benefit curve shows how;the benefit from undertaking one more;unit of an activity depends on the quantity of that activity that has already been;done.;Its clear from Table 7-5 that the more lawns Felix has already mowed, the smaller his;marginal benefit from mowing one more. So Felixs lawn-mowing business has what;economists call decreasing marginal benefit: each additional lawn mowed produces;less benefit than the previous lawn. Or, to put it slightly differently, with decreasing marginal benefit, the marginal benefit of an activity falls as the quantity already done rises.;Just as marginal cost could be represented with a marginal cost curve, marginal benefit can be represented with a marginal benefit curve, shown in blue in Figure 7-2.;The height of each bar shows the marginal benefit of each additional lawn mowed, the;curve through the middle of each bars top shows how the benefit of each additional;unit of the activity depends on the number of units that have already been undertaken.;Felixs marginal benefit curve is downward sloping, because he faces decreasing;marginal benefit from lawn-mowing. Not all activities have decreasing marginal benefit, in fact, there are many activities for which marginal benefit is constantthat is;it is the same regardless of the number of units already undertaken. In later chapters;where we study firms, we will see that the shape of a firms marginal benefit curve;from producing output has important implications for how it behaves within its;industry. Well also see in Chapters 10 and 11 why economists assume that declining;marginal benefit is the norm when considering choices made by consumers. Like;increasing marginal cost, decreasing marginal benefit is so common that for now we;can take it as the norm.;Now we are ready to see how the concepts of marginal benefit and marginal cost;can be brought together to answer the question of how much of an activity an individual should undertake.;500_12489_CH07_170-191;3/17/05;5:55 PM;Page 179;CHAPTER 7;Figure;MAKING DECISIONS;179;7-2;The Marginal Benefit Curve;The height of each bar is equal to the marginal;benefit of mowing the corresponding lawn. For;example, the 1st lawn mowed has a marginal benefit of $35, equal to the height of the bar extending;from 0 to 1 lawn. The bars descend in height;reflecting decreasing marginal benefit: each additional lawn produces a smaller benefit than the;previous one. As a result, the marginal benefit;curve (drawn by plotting points in the top center;of each bar) is downward sloping. >web...;Marginal;benefit of;lawn mowed;$35;30;25;Marginal benefit, MB;20;15;10;5;0;1;2;Marginal Analys


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