Marginal Analysis for optimal

decisions
Optimization Techniques
In Economics different optimization techniques as a solution
to decision making problems
Optimization implies either a variable is maximized or
minimized whichever is required for efficiency purposes,
subject to different constraints imposed on other variables
E.g. Profit Maximization, Cost Minimization, Revenue
Maximization, Output Maximization
A problem of maxima & minima requires the help of
differential calculus
Profit Maximization
Q TR TC Profit
0 0 20 -20
1 90 140 -50
2 160 160 0
3 210 180 30
4 240 240 0
5 250 480 -230
Profit Maximization
0
60
120
180
240
300
0 1 2 3 4 5
Q
($)
MC
MR
TC
TR
-60
-30
0
30
60
Profit
Profit Maximization
Total Profit Approach for Maximization
=TR-TC=> The difference to be maximized in
order to Max. Profit

TR
TC
Q
O
TR, TC
A
B
Marginal Analysis to profit maximization
Marginal Analysis requirement for profit
Maximization,
Marginal Revenue = Marginal Cost
(MR) (MC)
Marginal Value represents slope of Total value
curves,
Thus slopes of TR &TC should be equal


Two output level showing same slope, i.e.
MR=MC












TR
TC
Q
O
TR, TC
A
B
Q
2
Q
1

Interpretation of the previous diagram
MR=MC is a necessary condition for Maximization, not a
sufficient one as this condition also hold for loss maximization
Sufficient condition requires that reaching a point of
maximization, profit should start declining with any further
rise in output, i.e. Slope of TC should rise & Slope of TR must
fall after reaching the point of Maximization,
Change in MC>Change in MR
*Case Study to be discussed: An alleged blunder in the stealth
bombers design

Using derivatives to solve max and min problems
Optimization With Calculus
To optimize Y = f (X):
First Order Condition:
Find X such that dY/dX = 0
Second Order Condition:
A. If d
2
Y/dX
2
> 0, then Y is a minimum.
OR
B. If d
2
Y/dX
2
< 0, then Y is a maximum.
CENTRAL POINT
The dependent variable is maximized when its
marginal value shifts from positive to
negative, and vice versa
The Profit-maximizing rule
Profit( ) = TR TC
At maximum profit
dp/dQ = dTR/dQ - dTC/dQ = 0
So,
dTR/dQ = dTC/dQ (1
st
.O.C.)
==> MR = MC
d
2
TR/ dQ
2
= d
2
TC/dQ
2
(2
nd
O.C.)
==> dMR/dQ < dMC/dQ
This means
slope of MC is greater than slope of MR function
Constrained Optimization
To optimize a function given a
single constraint, imbed the
constraint in the function and
optimize as previously defined

OPTIMAL ADVERSTING EXPENDITURES
Number
of Ads
MBTV MBTV/PTV MBR MBR/PR
1 400 1.0 360 1.2
2 300 0.75 270 0.9
3 280 0.7 240 0.8
4 260 0.65 225 0.75
5 240 0.6 150 0.5
6 200 0.5 120 0.4
Optimal solution: Buy 2 TV ads and 4 radio ads
Optimal choice between number of TV and Radio Ads
Objective Function Maximize benefits (measured in sales)
Budget constraint of $2000, given PTV = $400 &PR=$300
Optimal condition: MBTV/PTV=MBR/PR