AVERAGE AND MARGINAL COSTS

•CASE OF MEMORIAL HOSPITAL (SHOULD

THERE BE MORE DELIVERIES)
•FIXED COST FALLACY
AVERAGE COST (AC) IS IRRELEVANT TO AN
EXTENT DECISION
•RECALL FORMULA FOR AVERAGE COST
•AVERAGE COSTS “HIDE” FIXED COSTS BY
LUMPING THEM TOGETHER WITH VARIABLE
COSTS
MARGINAL ANALYSIS
•TO ANALYZE EXTENT DECISIONS, WE BREAK DOWN THE DECISION
INTO SMALL STEPS AND THEN COMPUTE THE COSTS AND
BENEFITS OF TAKING ANOTHER ONE OF THESE STEPS.
•IF THE BENEFITS OF TAKING ANOTHER STEP ARE GREATER THAN
THE COSTS, THEN TAKE ANOTHER STEP.
•OTHERWISE, STEP BACKWARDS.
REVIEW
• MARGINAL COST (MC) IS THE ADDITIONAL COST INCURRED BY PRODUCING AND
SELLING ONE MORE UNIT.
• MARGINAL REVENUE (MR) IS THE ADDITIONAL REVENUE GAINED FROM SELLING ONE
MORE UNIT.
• RULE:
• SELL MORE IF MR > MC;
• SELL LESS IFMR < MC.
• IF MR =MC, YOU ARE SELLING THE RIGHT AMOUNT (MAXIMIZING PROFIT).
CASES
•MOBILE PHONE COMPANY ON TV ADVERTISING
•RELATIVE EFFECTIVENESS OF TV ADVERTISING VS
PHONE SOLICITATION
•FACTORY IN YUCATAN VS DOMINICAN REPUBLIC
INCENTIVE PAY
•HOW HARD TO WORK IS AN EXTENT DECISION, SO MARGINAL
ANALYSIS CAN BE USED TO DESIGN INCENTIVES TO ENCOURAGE
HARD WORK.
•CASE OF LANDOWNER
•MOTIVATING SALES PEOPLE
•TIE PAY TO PERFORMANCE MEASURES THAT REFLECT EFFORT
IF INCENTIVE PAY IS SO GOOD, WHY DON’T
MORE COMPANIES USE IT?
•ALFIE KOHN (1993) : RESEARCH SHOWS THAT REWARDS PUNISH.
• SAYING “IF YOU DO THIS, YOU’LLGET THAT” DIFFERS LITTLE
FROM SAYING “DO THIS OR THIS WILL HAPPEN TO YOU.”
•INCENTIVES ARE CONTROLLING.