.. e it popcorn, soft-drinks or something else entirely. The cost of one more video is one less of something else. It is impossible to escape from scarcity and opportunity costs. Given the limited resources available to any individual, the more of one thing always means less than another and the more of anyone service or product, the higher its opportunity cost.
Economic Growth The PPF defines a clear boundary between what is and is not attainable. However, that boundary is not static. It is constantly changing. At times the PPF moves inward, reducing production possibility. Other times, it moves outward. Using the “Joe’s Island” analogy for example, excellent growing and harvesting conditions would have the effect of pushing the production possibility frontier outward.
Expansion of production possibilities is termed economic growth. Over the last 100 years, the PPF has expanded exponentially. The question at hand for the new millennium appears to be how far can the economic envelope be pushed? The cost incurred in economic growth involves two key factors: capital accumulation, the growth of capital resources; and technological progress, new and better methods of producing goods and services. As a result of these factors in the nation’s current economic profile, there are an enormous quantity of trains, planes, and automobiles, producing far more available transportation than was experienced when only horses and buggies were available as transport. Satellites make transcontinental communications possible on a scale much larger than what could have been predicted using cable technology. However, accumulating capital and developing new technology are costly. Economic growth wears a cloak of trade-off.
If all resources are devoted to the production of food, clothing, houses, entertainment, and other consumer goods, and none to research, development, and accumulating capital, there will be no more capital and no better technologies in the future than exist at present. Production possibilities in the future will be exactly as they are today. Future economic expansion requires that fewer goods are produced for future consumption. Resources that are freed up today allow for the accumulation of capital. In turn, better technologies for the production of consumption goods can be developed in the future. The cut in output of consumer goods today is the opportunity cost of economic growth.
Household Consumer Choices Individuals determine what goods and services they will consume. The total quantity of those desired goods and services is called market demand. The relationship between the quantity of a good or service by a single individual and its price is called individual demand. Market demand is the sum of all individual demands. These demands are better understood by examining the mechanism used by households in making consumer choices.
Consumption choices made by households are determined by two factors: constraints and preferences. Consumer choices made by any household are limited by that household’s income and the price of the desired goods or services purchased. Marginal utility theory assumes that a household has a given income to spend and that it has no influence on the prices of goods or services it purchases. A representation of this theory follows: House A has a monthly income of $100.00 and is constrained by that limit. House A spends its dollar resources on only two items – books and beverages.
Books cost $6.00 each. Beverages cost .50 each or $3.00 a six pack. House A can purchase as many as ten six packs a month or five books a month. There are many other purchase combinations conceivable. Consumption possibilities can be visualized similar to the PPF, and the structure of Figure 1 is an excellent representation of such a consumption possibilities model. House A must decide how to divide the monthly income between books and beverages.
The likes and dislikes of the members of that household drive those purchasing decision. This is referred to as preference. Marginal utility theory uses the highly abstract concept of utility to describe those preferences. The concept of utility can best be explained with an analogy. Take, for example, the concept of temperature. It’s easy to understand the difference between feeling hot and cold, but hot and cold are not something observable. Water turns into steam when hot enough or ice when cold enough and those are observable phenomena.
In order to predict when such changes will occur an instrument can be constructed. Such an instrument is called a thermometer. The scale on the thermometer is the essence of temperature. The units used to measure that temperature are arbitrary. That is, the weight and value assigned to those units are subject to the judgment of the designer of the scale.
An accurate prediction of water turning to ice can be made when a thermometer using a Celsius scale reaches 0?. But the units of measure themselves are meaningless because this same events takes place when a Fahrenheit thermometer shows a temperature of 32?. The concept of utility allows for predictions about consumption choices in much the same way. It must be pointed out, however, that marginal utility theory is not as accurate as the theory that allows us to predict when water will turn to ice. Total utility refers to the total benefit, or pay out, derived from the consumption of goods or services.
The level of consumption determines the quantity of total utility. This concept can be illustrated by using the consumption possibilities of House A. Table 2 shows House A’s total utility from consuming different quantities of books and beverages. If no books are purchased in a month, there is no utility from books. If one book is purchased monthly 50 units of utility are assigned. Total Utility from Books and Beverages Table 2 Books Beverages Monthly Quantity Total Utility Monthly Quantity Total Utility 0 0 0 0 1 50 1 75 2 88 2 117 3 121 3 153 4 150 4 181 5 175 5 206 6 196 6 225 7 214 7 243 8 229 8 260 9 241 9 276 10 250 10 291 As the number of book purchases increase, total utility increases.
If ten books are purchased 250 units of utility are awarded. The other part of the table shows the total utility of beverage consumption. As beverages are consumed total utility rises. Marginal utility is that change in total utility resulting from a one-unit increase in the quantity of consumed goods or services. When consumption of books moves from four to five monthly, total utility from books increases from 150 to 175 units. Thus, for House A marginal utility of procuring a fifth book each month is 25 units.
Marginal utility appears midway between the quantities consumed. The change in consumption from four to five is what produces the marginal utility of 25 units. The more books House A purchases a month the more total utility it gets. However the marginal utility decreases, with each purchase. For example, marginal utility from the first book is 50 units.
The second book has a marginal utility of 38 units and the third, 33 units. This decrease in marginal utility as the consumption of a good increases is the principle of diminishing marginal utility. Marginal utility is positive but diminishes as consumption increases. These two features come about in this way: The members of House A enjoy reading so benefit from the purchase of books. That casts marginal utility in a positive light.
Marginal utility diminishes as more books are purchased due in part to opportunity cost and in part to lessening benefit. Those readers still enjoy a good book but the 30th is not quite as satisfying as the first. Utility maximization is the attainment of the greatest possible utility. A household’s income and the prices that it faces limit the utility that it can obtain. The model in Table 3 is used to examine the allocation of spending to establish the maximum total utility. Assume that Household A has $30.00 per month book and beverage budget.
When House A consumes two books and six beverages a month it receives 313 units of total utility. This is the best that can be done within the Any other combination of books and beverages generates less than 313 units of total utility. In maximizing total utility, that is, allocating income to achieve the most total utility units, consumer equilibrium is created. Books and Beverages Utility-Maximization Combinations Table 3 Books Total Utility from Beverages Quantity Total Utility Books & Beverages Total Utility Beverages 0 0 291 291 10 1 50 310 260 8 2 88 313 225 6 3 121 302 181 4 4 150 267 117 2 5 175 175 0 0 Predictions Based on Marginal Utility Theory This information allows for economic prediction. This is relevant because income and prices are not stagnant. What happens to House A’s consumption of books and beverages when their prices and House A’s income changes? Determining the effect of a change in price on consumption involves three steps: 1 Determine the combinations that can be purchased at new prices. 2 Calculate the new marginal utilities per dollar spent.
3 Determine the maximum utility resulting in consumer equilibrium. This process demonstrates that if, for example, the price of books falls but beverages remain constant in pricing, House A will most likely increase consumption of books and indulge in fewer beverages. If house A does not adjust it’s consumer habits it losses consumer equilibrium. A rise in income, however, brings about an increase in consumer goods. Should House A increase it’s books and beverages budget to $42.00 consumer equilibrium is reached when seven books and seven beverages are purchased monthly. Marginal utility theory is used by economists to answer a wide range of questions.
An example of this can be found in it’s application in determining the fluctuations in popularity between wooden and aluminum baseball bats. Another example is the ability of the theory to answer questions about patterns of consumer spending. But as well as explaining consumption choices, it can be used to explain all household choices. The allocation of time as well as capital can be decided using marginal utility theory. And it’s often been stated that time equates to money.
In Conclusion What does all this mean to the modern consumer? There becomes a point for consumers when all resources, intangible capital such as time as well as tangible dollars, goods and services, has to be factored into the cost/benefit analysis of consumption and production. Making intelligent consumer choices requires a clear understanding of the opportunity cost and an applied strategy for maximizing total utility. When that takes place a window for technological advancement is opened. New technologies enable producers to eliminate some of those factors that drive up production costs and therefore prices. For example, the development of new technology for the manufacture of tape by companies such as 3M has lowered the cost of producing tapes and increased the available supply. Technology advances in the area of sticky products is now available and affordable to the masses.
However, that technology has also made obsolete other goods and services. Tape sales may be up due to market demand created by new tape technology, but the market for library paste is drying up. Makers of library paste may or may not be able to hold enough market share to continue production. But until it is no longer economically feasible to produce library paste, consumers have choices beyond tape when considering sticky products. Basically, consumers are faced with more choices than at any time ever before.
In a spiraling effect, these consumer choices have created the opportunity for increasing technology. And that technology has changed every aspect of day to day life and all human transactions. We live in a style that previous generations could not have imagined. Goods such as home videos and microwave popcorn now appear on the average shopping list. Advances in medicine have cured previously fatal diseases. Homes are more spacious, people eat better, grow taller, and are even born larger than in past generations. Economic growth and technological change have made the current generation richer than the generations of our parents and grandparents.
But we have not created Utopia. As a society we experience opportunity cost with each new technological advancement. The extent of that cost can be measured with the tools of microeconomics that have been examined in this paper. Possible production frontier graphs can be employed in the planning and decision making stage prior to production. Determining how an item is priced, and therefore its’ profitability, is a function of marginal utility theory.
All of this helps industry to decide if and how to go about introducing new products and technology. That’s critically important simply because just because we can, it doesn’t always mean we should. Seal Straugh Notes Bibliography C. Menenger, Principles of Economics, (Grove City PA, Libertarian Press) 1994, 12 Michael Parkin, Microeconomics, 2nd Edition, (New York, Addison-Wesley Publishing Company) 1993, 12 Parkin, 18 Menenger, 33-36 Xiphaias, producer, Economics Alive! CD-ROM 1994 IBM William Baumol, and Alan Blinder, Economics Principles and Policy, 4th Edition, (New York University and Princeton University, Harcourt Brace Jovanovich, Publishers) 1988, 122 Baumol and Binder, 74 Danila Israel, “Review of Microeconomic Models and Valuation Methods Applied in the Natural Resources and Environmental Sector” Eastern Economic Journal, May, 1998 vol. 2, (Boston, Mass., Asset Publication) 144-157 Parkin, 53 Menenger, 112 Economics Alive! CD-ROM Parkin, 222 Israel, 123 Parkin, 359 Israel, 166 Economics Alive! CD-RO Parkin, 260 Israel, 166 Israel, 169 Eric N.
Berg, ” Wood Makes Baseball Comeback,” New York Times, July 7, 1986 Bibliography Primary Sources Books Baumol, William & Blinder, Alan, Economics Principles and Policy, 4th Edition, New York University & Princeton University: Harcourt Brace-Javonovich, Publishers, 1988 Meneger, C., Principles of Economics, Grove City PA: Libertarian Press, 1994 Parkin, Michael, Microeconomics, 2nd Edition, New York: Addison-Wesely Publishing, 1993 Collected Documents Berg, Eric N., “Wood Makes Baseball Comeback”, New York Times, July 7, 1991 Israel, Danila, “Review of Microeconomic Models and Valuation Methods in the Natural Resources and Environment Sector”‘ Eastern Economic Journal, May, Vol. 2, Boston: Asset Publication, 1998 Electronic References Xiphaias, Economics Alive! CD-ROM 1994 IBM Social Issues.