Utility Diminishing Returns and Comparative Advantage Lesson Objectives

Utility, Diminishing Returns, and Comparative Advantage

Lesson Objectives • Identify examples of different forms of utility and explain how this concept drives consumption and production decisions within an environment of diminishing marginal returns • Demonstrate the ability to apply information drawn from measuring diminishing marginal returns and increasing opportunity costs to a business example

Key vocabulary • • • Allocative efficiency Comparative Advantage Diminishing Marginal Utility Diminishing Returns Marginal Physical Product • • Marginal Utility Production Efficiency Specialization Utility

Too much of a good thing Term Category Characteristics Utility is An economic concept that represents the amount of benefit or satisfaction received from the consumption of a good or a service Marginal Utility is An economic concept that refers to the amount of benefit or satisfaction received from each additional increment of consumption of a good or a service Diminishing marginal utility is An economic concept that suggests that each additional increment of consumption of a good or services begins to bring about less marginal utility

Assignment • Take a very deep breath • Now hold it until I say not to…. • • Rate your first breath on a scale from 1 -10 Rate your second breath on a scale from 1 -10 Rate your third breath Rate your fourth breath

Assignment • Download marginal utility worksheet • Answer questions 1 and 2 only • Now as student eats the cracker fill out question 3 • Tally the differences in the unmarked fourth column of the worksheet and find the total at the bottom

Total Utility • Download Maximizing Utility at the Pizzeria • Fill out worksheet

Diminishing Returns • Does too much of a good thing apply to the production side of business?

Diminishing Returns • Explain that each team is a company that produces greeting cards • The resources needed to produce the cards are a sheet of white paper folded in half, three circles cut from a sheet of colored paper glued to the outside of the white paper, and a color marker used to write “Yappy Hew Near” on the inside of the card ▫ consumers are picky and will reject poorly constructed products

Diminishing Returns • Download: Diminishing Returns in the Greeting Card Business • Read the opening narrative and directions, and assign one group member the role of timer ▫ The timer is important to record all of the relevant information, these data will be used to determine how many workers the company should hire—in other words, how the company can run most efficiently

Diminishing Returns • Once production complete and all teams members included answer the questions • Workers face a learning curve for new tasks, which almost always negatively impacts their efficiency • Economists call this the law of increasing opportunity costs

Introduction to Increasing Opportunity Cost • Companies face scarce resources and must make decisions on how best to put those resources to work for their own objectives ▫ Companies need profit ▫ Individuals need utility • Companies are most technically efficient when they are producing the maximum amount with the resources given

Introduction to Increasing Opportunity Cost • Economically efficient is when they are maximizing the difference between the market value of what they produce, minus the costs they incur—that is, maximizing their profit

Pre-Reading Questions • Why can’t a worker move easily from a factory building cars to one building computers? • Why might a strong math student begin to do poorly in that subject after her family moved to a new country?

Production Possibility Curve and Business • Examines production efficiency through the production possibility curve ▫ Take up the relationship between efficiency in production and allocative efficiency • Download: Production Possibility Curve • This curve represents two different goods that a company can produce • All points along the line represent technically efficient production

Production Possibility Curve and Business • All points inside the line represent technically inefficient production • Points outside the line represent situations that are currently not possible • Read the article

Production Possibility Curve and Business • Why do you think companies try to operate right on the production possibilities curve? • Why is it inefficient for a company to operate inside of its production possibilities curve? • Why does the line curve? • What kinds of things need to change for a company to operate outside of the current production possibility curve?

Production Possibility Curve and Business • Write down three questions you would need answered if you were deciding how the greeting card company should allocate its workers given the information provided by the PPC graph

You’re the Manager • The company president has asked you to use the data collected and observations made during the exercise on creating a greeting card to come up with some suggestions as to how the card company might increase its production efficiency

You’re the Manager • Download: Company Economist Memo • The memo was written by the company’s lead economist who is asking you for a set of recommendations to increase efficiency and shift the production possibility curve • Read the article • How would you increase the company’s efficiency?

You’re the Manager • Download: Student Memo Template ▫ Use it to frame your recommendations

Relevance • Operations Research and Statistics • Used in real business to determine what to produce and when while allocating the correct amount of workers

Cross-Curricular Integration • The concept of diminishing returns arose, in part, out of work done in the nineteenth century by British financial trader and economist David Ricardo, and by the philosopher and economist Thomas Malthus. ▫ Ricardo noted, for example, that if you doubled the yearly work effort (“labor input”) devoted to a certain area of land on a farm, you would not double the amount of food produced—the increase in output would be less than that.

Cross-Curricular Integration • Increasing the labor input once more, by the same increase in work hours, would increase the amount of food produced by even less—diminishing returns would set in. • Expanding on Ricardo’s work, Malthus predicted that the growth of human population would outstrip food production, so that starvation would ultimately act as a check on global population growth. • With world population having increased nearly sevenfold since Malthus made his claim, we might be inclined to reject his entire premise. • Yet, new arguments have been made regarding population, global resources, and our species’ long-term viability.

Cross-Curricular Integration • Research a current example in the world of science and climatology to which the Malthusian vision of diminishing returns might apply, and present information on the diminishing returns. • Include: ▫ Where in the world returns are diminishing? ▫ What is the limiting resource? �Is it possible to change the availability of the resource? ▫ What is the current utility of the product/ service? ▫ How would you improve the situation?