Overview
This lecture explains the concept of making decisions "on the margin," focusing on comparing marginal benefits and marginal costs to guide rational choices.
Marginal Thinking and Decision-Making
- Decisions are made at the margin, meaning we consider the impact of one additional unit.
- Marginal means the next or additional unit of consumption or production.
- Rational decision-making compares marginal benefit (MB) to marginal cost (MC).
- If MB ≥ MC, you should proceed with the activity.
- Choices often involve small, incremental changes (not all-or-nothing decisions).
Cost-Benefit Principle
- The cost-benefit principle states you continue an activity as long as MB is greater than or equal to MC.
- MB and MC are used to evaluate whether to increase or decrease consumption or production.
Example: Buying Tacos
- Buying the first taco: MB = $8, MC = $5; you should buy it because MB > MC.
- Buying the second taco: MB = $6, MC = $5; still worth it since MB > MC.
- Buying the third taco: MB = $2, MC = $5; not worth it because MB < MC.
- Compare MB to MC for each additional taco, not total benefit to total cost.
The Diamond-Water Paradox
- Adam Smith’s diamond-water paradox: Water is essential but cheap, diamonds are non-essential but expensive.
- Water’s MB is low due to abundance; diamond’s MB is high due to scarcity.
- Prices reflect marginal, not total, benefit.
Key Terms & Definitions
- Marginal — relating to one additional or next unit.
- Marginal Benefit (MB) — the extra benefit received from consuming or producing one more unit.
- Marginal Cost (MC) — the extra cost incurred from consuming or producing one more unit.
- Cost-Benefit Principle — continue an activity if the marginal benefit is at least as large as the marginal cost.
- Scarcity — the limited nature of resources, affecting marginal values.
Action Items / Next Steps
- Review examples of marginal analysis for homework.
- Practice applying the cost-benefit principle to everyday decisions.