EI 100.40 Marginal Cost & Marginal Benefit Defined

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“In this lecture. We re going to talk about marginal cost and marginal benefit in in economics. We often think about decision making happening on the margin. So when we decisions we want to make decisions on the margin that means that we re measuring the costs and the benefits at the margin that means we re measuring from here going forward at this point in time.

It is what it is we can t change the past. It is what it is here therefore a relevant decision making needs to include the costs and the benefits going forward from this point forward for the next step not taken into consideration the costs and benefits that have already happened in the past because they should not affect the current decision making process. Most decisions that we make we make intuitively. So we usually just kind of have this process in our mind.

And we make this process in these decisions. Intuitively and we usually do have some type of system..

That generally measures our marginal cost and marginal benefits from an economic standpoint. We want to have a model put in place in order to model people s normal behaviors. People normal behavior. And that s going to be including this idea of marginal cost and marginal benefits.

There s benefits to that model. One is that that model helps economists to make predictions it helps us to see a formal process to decisions that are going to be made intuitively and it can also help us to analyze decisions when decisions go wrong. So when we have areas where our intuitive decision does not make as good a process. We can put these more formal processes in in order to make those types of decisions.

So if we re thinking about something like sunk a sunk cost effect. Where we put a lot of good money after bad..

If you ve heard the term they re putting good money after bad. That s the concept of in larger decisions. When we ve already put a lot of investment in something we tend to make decisions that aren t as rational because we try to put the good money after bad instead of measuring. Where we are at at this point in time and thinking of what we should do going forward.

We also have decisions when the benefits and the costs are separated in time it becomes a lot more difficult for us to make decisions. Intuitively and if we do it more formally using an equation in terms of marginal cost and marginal benefits. It can be useful in those areas. So the basic question.

Here is should i have another slice of pizza or not and of course in terms of cost. Even if the pizza is free there are still a cause from an economic turn nothing that s free..

We still got to get up we still got to get the pizza and we have to consider whether the pizzas gonna do good for us. So we can have to run it off later or not is it better for us to consume the pizza or not intuitive. We know that the past is done whatever we ve eaten in the past is done we can t undo that we are where we at at this point in time. We re as full as we are at this point in time and of course.

The decision we need to make is as of this point in time should we consume another piece of pizza or not measuring the cost and the benefits under the formal calculation of costs and benefits of course for the next unit of pizza from this point going forward. If the benefit we re getting from just satisfaction of the pizza or whatever the benefit may be and in terms of things not just money. We re not just talking money here. We re talking just overall benefit not the easiest thing to measure.

But from a theoretical sense. We could say okay if our total benefit from having the pizza is greater than the marginal cost the marginal benefit greater than the marginal cost being the cost of that next two slice of pizza at the margin at this point..

In time at this point in time going forward. If the marginal benefit is greater than the marginal cost. Then we re gonna say yes we want to eat the pizza. If the marginal benefit is less than the marginal cost then we re going to say no we don t want to eat the pizza and again no one really thinks this way in terms of normal day to day decisions.

But from an economic standpoint. It helps to have a model such as this in order to analyze decision making and so this type of model is going to come up a lot within. Economics and when we get to more complex decisions. Seeing a formal model of decision making really helps when there s pitfalls within normal decision making processes.

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