Chapter 3: Marginal Analysis for Optimal Decisions Flashcards
activities or choice variables
Variables that determine the value of the objective function.
average (unit) cost
Total cost per unit of activity computed by dividing total cost by the number of units of activity. [TC/A]
constrained optimization
An optimization problem in which the decision maker chooses the levels of two or more activities that max or min the objective function; chooses values for the choice variables from a restricted set of values.
continuous choice variables
A choice variable that can take any value between two end points. (2, 2.345, 7.9….22.56) [usually shown graphically]
discrete choice variables
A choice variable that can take only a countable number of values / integer value. (1,2,3….10,20,30…) [usually shown in a table]
fixed costs
Costs are constant and must be paid no matter what level of the activity is chosen
marginal analysis
Analytical technique for solving optimization problems that involves changing values of choice variables by small amounts to see if the objective function can be further improved. / comparing MB and MC to see if NB can be increased by making incremental changes to level of activity
marginal benefit (MB)
The change in total benefit caused by an incremental change in the level of an activity. [chTB/chA]; slope of the line tangent to the total benefit
marginal cost (MC)
The change in total cost caused by an incremental change in the level of an activity. [chTC/chA]; slope of the line tangent to the total cost
maximization problem
An optimization problem that involves maximizing the objective function.
minimization problem
An optimization problem that involves minimizing the objective function.
net benefit
The objective function to be maximized:
NB = TB − TC.
objective function
The function the decision maker seeks to maximize or minimize.
optimal level of activity
The level of activity that maximizes net benefit (A*); marginal benefits = marginal cost; total benefits - total costs is greatest
sunk costs
Costs that have previously been paid and cannot be recovered.
unconstrained optimization
An optimization problem in which the decision maker can choose the level of activity from an unrestricted set of values.
2 important observations in unconstrained maximization problems
- optimal level of activity does not generally result in maximization of total benefits
- optimal level of activity in an unconstrained maximization problem does not result in minimization of total cost
economists regard marginal analysis as…
the central organizing principal of economic theory
marginal vs. total
marginal benefit and marginal costs are slopes of total benefit and total cost curves, respectively
general constrained maximization problem
manager must choose the levels of two or more activities in order to maximize a total benefit function subject to a constraint in the form of a budget that restricts the amount that can be spent
