CHAPTER 6

Reporter: Caballero, Dianne

LO 1: UTILITY ANALYSIS

Utility Analysis is a quantitative method that estimates the dollar value of benefits
generated by an intervention based on the improvement it produces in worker
productivity.

 Utility is a term used by economists to describe the measurement of "useful-

ness" that a consumer obtains from any good. Utility is the want satisfying
power of any commodity or capacity of a commodity to give satisfaction. The
ability of a good to satisfy a want. An economic term used to represent
satisfaction or happiness.

Tastes and preferences. All markets are shaped by collective and individual tastes
and preferences. These patterns are partly shaped by culture and partly implanted
by information and knowledge of products and services (including the influence of
advertising).

Consumer preferences are expectations, likes and dislikes, motivations and

inclinations that drive customer purchasing decisions. They
complement customer needs in explaining customer behavior.

The Law of Diminishing Marginal Utility

The Law of Diminishing Marginal Utility states that all else equal as consumption
increases the marginal utility derived from each additional unit declines.
Marginal utility is derived as the change in utility as an additional unit is
consumed. Marginal utility is the incremental increase in utility that results from
consumption of one additional unit.

Key Differences between Total and Marginal Utility

The significant differences between total and marginal utility are explained in the
points given below:

1. Total Utility means overall benefit obtained by a person from

consumption of goods and services. Marginal Utility means the amount of
utility a person gets from the consumption of each successive unit of a
commodity.
2. In general, the total utility increases as more of a commodity is
consumed. As against this, the marginal utility decreases with each
additional unit of a commodity consumed.
3. There is a certain saturation point of satisfaction, where the consumer no
longer gains satisfaction with the consumption of the commodity, once
that point has reached. This shows that total utility suffers from decreasing
returns. Unlike marginal utility, which declines with each additional unit
of the commodity consumed.

Reporter: Diaz, Janilla

LO 2: MEASURING UTILITY

A consumer's utility is hard to measure, however, but it can be determined

indirectly with consumer behavior theories, which assume that consumers will
strive to maximize their utility.

In economics, utility function is an important concept that measures preferences

over a set of goods and services. Utility is measured in units called utils, which
represent the welfare or satisfaction of a consumer from consuming a certain
number of goods. Because satisfaction, happiness or welfare is a highly abstract
concept, economists measure utility in terms of revealed preferences by observing
consumer choices and creating an ordering of consumption baskets from least
desired to the most preferred.

UTILITY  MAXIMIZATION  IN  A  WORLD  WITHOUT SCARCITY

AND UTILITY­MAXIMIZING CONDITIONS

Utility maximization is the guiding notion underlying consumer choices analyzed

with consumer demand theory and utility analysis. It makes sense to think that
people are generally motivated to do what is best for them, to purchase the most
satisfying goods, to make the decisions that do more good than harm, to improve
their overall living standards and well-being, that is, to maximize their utility.

The utility maximization goal is based on the seemingly obvious presumption that
people prefer more to less. This presumption is tied to the unlimited wants and
needs aspect of scarcity. In other words, because people have unlimited wants and
needs, satisfying those wants and needs is a desirable thing to do.

The resources are limited although they are significant in fulfilling the wants that
are unlimited as depicted by consumers. Due to the scarcity issues facing the
resources, the demand is created. The resources provide the supply of all things
that could be used to fulfill all needs. However, the needs of consumers reflect the
demand. Due to many consumer needs, the demand for products is usually high
and consumers have to budget their purchases based on monetary resources
available (that are also limited).

Reporter: Bugayong, Sheena Mae

LO 3: MARGINAL UTILITY AND LAW OF DEMAND

MARGINAL UTILITY

Marginal utility is the additional satisfaction or benefit (utility) that a

consumer derives from buying an additional unit of a commodity or service. It is
also the value that an individual enjoys by purchasing one more item. As a general
principle, marginal utility declines the more you buy as seen on the illustration
below.

Now, how does marginal utility relates to the law of demand?

The law of diminishing marginal utility states that marginal utility declines as
consumption increases. Because demand price depends on the marginal utility
obtained from a good, price also declines as consumption increases, meaning price
and quantity demanded are inversely related, which is the law of demand.

Table 4.1 gives some hypothetical figures showing the total and marginal utility
derived by a consumer from consumption of product X. When the individual
consumes one unit, he derives 20 utils of satisfaction. When he consumes two units
in the week, his total utility rises to 50 utils and so on.

The figures for marginal utility eventually decline as each successive units are
consumed.
If we assume that consumers are utility-maximizers, they wish to obtain as much
utility as they can, subject to no other constraints, the consumer in Table 4.1 would
consume 4 units of X where total utility is greatest.

CONSUMER SURPLUS

In a nutshell, the total amount those consumers are willing and able to pay for a
good or service and the total amount that they actually do pay.

Reporter: De Vera, Jocelle Michael

LO 04: THE ROLE OF TIME IN DEMAND 

Because consumption does not occur instantly, time plays a role in demand
analysis. Consumption takes time and, as Ben Franklin said, “time is money”—
time has a positive value for most people. Consequently, consumption has a money
price and a time price. Goods are demanded because of the benefits they offer. It is
not the microwave oven, personal computer, airline trip, or headache medicine that
you value but the services they provide. Other things constant, you would gladly
pay more to get the same benefit in less time, as with faster ovens, computers,
airline trips, and headache relief. Likewise, you are willing to pay more for
seedless grapes, seedless oranges, and seedless watermelon.

CHAPTER 7
Reporter: Salazar, Cheska Nicole

LO 1: COST AND PROFIT

What is cost?

Cost is an amount that has to be paid or given up in order to get something.

In business, cost is usually a monetary valuation of (1) effort, (2) material, (3)
resources, (4) time and utilities consumed, (5) risks incurred, and (6) opportunity
forgone in production and delivery of a good or service. All expenses are costs, but
not all costs (such as those incurred in acquisition of an income-generating asset)
are expenses.

Implicit Cost

In economics, an implicit cost, also called an imputed cost, implied cost, or

notional cost, is the opportunity cost equal to what a firm must give up in order to
use a factor of production for which it already owns and thus does not pay rent. It
is the opposite of an explicit cost, which is borne directly. In other words, an
implicit cost is any cost that results from using an asset instead of renting it out or
selling it. The term also applies to foregone income from choosing not to work.

Explicit Cost

An explicit cost is a direct payment made to others in the course of running a

business, such as wage, rent and materials, as opposed to implicit costs, where no
actual payment is made. It is possible still to underestimate these costs, however:
for example, pension contributions and other "perks" must be taken into account
when considering the cost of labor.
What is profit?

Profit is a financial benefit that is realized when the amount of revenue

gained from a business activity exceeds the expenses, costs, and taxes needed to
sustain the activity. Any profit that is gained goes to the business's owners, who
may or may not decide to spend it on the business.

Formula:

 Accounting Profit
Accounting profit is a company's total earnings, calculated according to generally
accepted accounting principles (GAAP). It includes the expenses, depreciation,
interest and taxes.

Formula:
  Economic Profit
Economic profit is similar to accounting profit in that it deducts explicit
costs from revenue. However, economic profit also includes the opportunity costs
for taking one action versus another in the period. Economic profit is determined
by economic principles, not by accounting principles.

Formula:

 Normal Profit
Normal profit is an economic condition that occurs when the difference
between a firm’s total revenue and total cost is equal to zero. Simply put, normal
profit is the minimum level of profit needed for a company to remain competitive
in the market.

Reporter: Corpuz, Ron

LO 2: PRODUCTION IN THE SHORT RUN

Production is the process a firm uses to transform inputs (e.g. labor, capital,
raw materials, etc.) into outputs. It is not possible to vary fixed inputs (e.g. capital)
in a short period of time. Thus, in the short run the only way to change output is to
change the variable inputs (e.g. labor).

 Fixed inputs are those that can’t easily be increased or decreased in a short
period of time.
 Variable inputs are those that can easily be increased or decreased in a short
period of time.
Economists often use a short-hand form for the production function:

Where:

L represents all the variable inputs, and K represents all the fixed inputs.

Economists differentiate between short and long run production.

The short run is the period of time during which at least some factors of
production are fixed.

The long run is the period of time during which all factors are variable.

What is Law of Diminishing Marginal Returns?

The law of diminishing marginal returns states that, at some point, adding an
additional factor of production results in smaller increases in output. For example,
a factory employs workers to manufacture its products, and, at some point, the
company operates at an optimal level. With other production factors constant,
adding additional workers beyond this optimal level will result in less efficient
operations.

Reporter: Sitchon, Nychi Airon

LO 3: PRODUCTION AND COST IN THE FIRM

COSTS IN THE SHORT RUN

The Cost in the Short run is the cost which has short-term implications in the
production process, i.e. these are used over a short range of output. These are the
cost incurred once and cannot be used again and again, such as payment of wages,
cost of raw materials, etc.
Following are the cost concepts that are taken into consideration in the short run:

a. Fixed Costs

Refer to the costs that remain fixed in the

short period. These costs do not change with
the change in the level of output. For
example, rents, interest, and salaries. Fixed
costs have implication even when the
production of an organization is zero. These
costs are also called supplementary costs,
indirect costs, overhead costs, historical costs, and unavoidable costs.

FC remains constant and independent with respect to change in the level of output.
Therefore, the slope of FC curve is a horizontal straight line.

b. Variable Costs (VC):

Refer to costs that change with the change in

the level of production. For example, costs
incurred on purchasing raw material, hiring
labor, and using electricity. If the output is zero,
then the variable cost is also zero. These costs
are also called prime costs, direct costs, and
avoidable costs.

The below are the Key Differences between both:

 Fixed cost is a cost that remains same regardless of volume of

production while variable cost changes with the level of production.

 Fixed cost is a time related while variable cost is a volume related.

 Fixed costs are required to pay whether there is production or not.

Variable costs only occurred when there is production.
  Variable costs remain same per unit while fixed cost per unit changes. In
case of large production, per unit fixed cost decrease and vice versa.

 Examples of fixed costs are: depreciation, rent, salary, insurance, tax etc.
Examples of variable costs are: material consumed, wages, commission on
sales, packaging expenses, etc.

c. Total Cost (TC):

It involves the sum of FC and VC. It can be

calculated as follows: Total Cost = FC + VC

TC also changes with the changes in the level

of output as there is a change in VC.

It should be noted that both VC and TC

increase initially at decreasing rate and then
they increase at increasing rate Here,
decreasing rate implies that the rate at which cost increases with respect to output
is less, whereas increasing rate implies the rate at which cost increases with respect
to output is more.

d. Marginal Cost:
Refer to the addition to the total cost for producing an additional unit of the
product. It is also calculated as: MC = ∆TC/∆Output
 MC curve is also a U-shaped curve as
marginal cost initially decreases as output
increases and afterwards, rises as output
increases. This is because TC increases at
decreasing rate and then increases at
increasing rate.

e. Average Cost (AC):

Refer to the total costs of production per unit of output. AC is calculated as: AC =
TC/ Output

AC is also equal to the sum total of

AFC and AVC. AC curve is also U-
shaped curve as average cost initially
decreases when output increases and
then increases when output increases.

Reporter: Foronda, Stefi Mae
LO 4: COSTS IN THE LONG RUN

Long run costs are accumulated when firms change production levels over
time in response to expected economic profits or losses. The long run is a planning
and implementation stage for producers. They analyze the current and projected
state of the market in order to make production decisions. Efficient long run costs
are sustained when the combination of outputs that a firm produces results in the
desired quantity of the goods at the lowest possible cost. It can be also termed as
the least possible cost of producing any given level of output when all inputs are
variable. LTC is always less than or equal to short run total cost, but it is never
more than short run cost.

ECONOMIES OF SALE

These are the costs that are incurred by companies when production
becomes efficient. Economies of scale are an important concept for any business in
any industry and represent the cost-savings and competitive advantages larger
businesses have over smaller ones. The cost per unit depends on how much the
company produces hence it is an advantage for large companies. They are able to
produce more by spreading the cost of production over a larger amount of goods.
The main point is, as the scale of the firm increases, capital substitutes for labor
and complex machines.

DISECONOMIES OF SALE
 This happens when a company or business grows so large that the costs per
unit increase. It takes place when economies of scale no longer function for a firm.
With this principle, rather than experiencing continued decreasing costs and
increasing output, a firm sees an increase in costs when output is increased.
Diseconomies of scale specifically come about due to several reasons, but can be
broadly categorized as internal or external. Internal diseconomies of scale can arise
from technical issues of production or organizational issues within the structure of
a firm or industry. External diseconomies of scale can arise due to constraints
imposed by the environment within which a firm or industry operates. Essentially,
diseconomies of scale are the result of the growing pains of a company.

LONG­RUN AVERAGE COST CURVE

Long-run average cost is the per unit cost incurred by a firm in production
when all inputs are variable. In particular, it is the per unit cost that results as a firm
increases in the scale of operations by not only adding more workers to a given
factory but also by building a larger factory.