1.4: Cost-Benefit Analysis and Marginal Analysis

Trade-offs v. opportunity cost

→ All decisions involve trade-offs

Trade-off: all of the alternatives that we give up when we make a choice
Opportunity cost: most desirable alternative given up when you make a choice

Explicit v. implicit costs

Explicit cost: the traditional out-of-pocket cost associated with making a decision
- Eg. the price of a movie ticket
Implicit cost: the opportunity cost of making a decision
- Eg. the forgone time or wage you could have earned while at the movies

Factor v. transfer payments

Productive v. allocative efficiency

Productive efficiency: a situation in which a good or service is produced at the lowest possible cost
Allocative efficiency: when the mix of goods being produced represents the mix that society most desires

In economics, marginal means “additional”
Marginal analysis: making decisions based on increments
- Eg. when you decide to go to the mall, you consider the additional benefit and the additional cost (your opportunity cost)
- Point: you will continue to do something as long as the marginal benefit is larger than the marginal cost
Marginal utility: the additional satisfaction or benefit that a consumer derives from buying an additional unit of a commodity or service
- To determine marginal utility, marginal cost and benefit must be taken into account
- Marginal cost: the additional benefit to a consumer from consuming one more unit of a good or service
- Marginal benefit: the cost of producing one more unit of a good

Law of diminishing marginal utility: as you consume anything, the additional satisfaction that you will receive will eventually start to decrease
- Ie. the more you buy of any good, the less satisfaction you get from each new unit consumed
- Same point as before
Utility maximizing rule: equating the ratio of the marginal utility of a good to its price for all goods