Economic Unit 1 Lesson 3 Part 2

The change in the total benefit that comes from an action is the

marginal benefit

Effective decision-making means comparing the additional costs of alternatives with the

marginal benefits

The expense of making an additional shirt is known as the

marginal cost

If the marginal benefit of an activity is greater than its marginal cost, people are better off doing

more of the activity

COMPARE CHOICES IN A COST-BENEFIT ANALYSIS

In a cost-benefit analysis, you examined the costs and benefits of your choices. Then, you made a decision based on the choice that would maximize your benefits, with the least costs. Effective decision-making actually requires comparing the additional benefits of alternatives with the additional costs. Because few choices are all or nothing, most choices involve getting an extra amount of something and giving up an extra amount of something else. As long as the marginal benefit of an activity is greater than the marginal cost, people are better off doing more of the activity. But, when the marginal cost is greater than the marginal benefit, then people are better off doing less of the activity.

MARGINAL BENEFITS, MARGINAL COSTS, AND MARGINAL UTILITY

Marginal Benefit Think back to the first chip that you ate. This action brought you satisfaction. When you ate the second potato chip, it brought you extra satisfaction. This extra satisfaction might not have been as much as you gained from eating the first chip, but it was satisfaction (or utility) that added to the total satisfaction that you received from eating chips. In economics, this additional benefit that you gained by eating the second chip is called a marginal benefit. Marginal benefit refers to the change in the total benefit that comes from an action, in this case eating a potato chip. Marginal Utility Since seeing is believing, let's illustrate the idea of gaining additional satisfaction by using numbers and a table. The number of chips that you eat will go into the first column, and the amount of satisfaction (or utility) that you feel from eating these chips will go in the second column. As you already know, satisfaction is difficult to measure in numbers. But for this example, suppose there is a measurement called "units of happiness." There will also be a third column in the table called "Marginal Utility." This column refers to the extra amount of satisfaction that you get from one more unit of a good or service- in this case, one more chip. In math terms, marginal utility = total utility minus the total utility in the row above. For example, marginal utility from eating 2 chips = 15 (total utility from eating 2 chips) minus 10 (total utility from eating 1 chip). Marginal Cost Where there is a benefit, there is also a cost! Marginal cost has to do with an additional unit of a good or service, too. But instead of looking at the change in total benefits gained from each additional unit, marginal cost focuses on the change in the total costs resulting from an action.

marginal benefit

change in total benefit resulting from an action

marginal cost

change in total cost resulting from an action

marginal utility

change in total utility resulting from an action

The law of diminishing utility states that as you consume more of a good, the satisfaction that you feel

decreases

marginal

extra or additional (in economics)

utility

happiness; satisfaction