Principles of Economics – Marginal Analysis

Principles of Economics – Thinking Like an Economist

Economists assume that “rational people think at the margin.” This means every decision is evaluated by comparing the additional (marginal) benefit to the additional (marginal) cost created by a small, incremental change to an existing plan.

Marginal Change

• A marginal change is a small, incremental adjustment to a plan of action.
• In symbols, if an action raises total benefit (TB) from TB0 to TB1, the marginal benefit is MB = TB1 - TB0; an analogous formula applies for marginal cost (MC).

Example 1: New Savings Account

Active-learning questions & answers:

1. Marginal change on 03 September: 630 - 480 = 150. (A deposit of 150.)
2. Total deposit on 29 September after a +100 deposit: 630 + 100 = 730.
3. Marginal change on 17 October: 430 - 730 = -300 (a withdrawal of 300.)

Marginal Analysis: Conceptual Framework

• We evaluate each option by comparing MB and MC of the next (marginal) unit.
• Optimal rule for a rational decision-maker: \text{Choose the action if } MB > MC.
• If MC > MB, do not undertake the action.

Example 2: The Cookie Decision

Scenario:

• Rashna has already bought 6 cookies for a total of 9 (price per cookie = 9/6=1.50).
• She is deciding whether to buy a 7th cookie (the marginal unit).

Definitions introduced:

• Marginal cost (MC) – the price Rashna must pay for that cookie (here, MC = 1.50).
• Marginal benefit (MB) (a.k.a. marginal utility) – the extra “satisfaction” from eating that cookie.

Cost–benefit logic:

• If MB > 1.50 ⇒ buy; if MB < 1.50 ⇒ do not buy.

Diminishing Marginal Utility

Illustrated on slides with an (incomplete) table:

Principle: As consumption increases, the satisfaction derived from each additional unit declines. This downward-sloping MB schedule explains why people eventually stop buying more even if price is constant.

Example 3: Bus-Trip Pricing (Active Learning)

Context: A 40-seater bus trip from Kuala Lumpur to Ipoh.
Costs (mostly fixed for the evening):

• Bus rental: RM 220 (fixed)
• Driver services: RM 100 (fixed)
• Petrol & tolls: RM 80 (fixed)
• Food & beverage: RM 5 per passenger (variable)
• List ticket price: RM 30

Five minutes before departure a seat is still empty. A late customer offers RM 10 for the ticket. Should you sell? Use marginal analysis:

• Marginal cost (MC) of adding one passenger: only the variable part, i.e. food & beverage = RM 5.
• Marginal benefit (MB) = ticket revenue = RM 10.
• Since MB - MC = 10 - 5 = 5 > 0, rational choice is Yes, sell the seat. (Fixed costs are sunk; they do not change with this extra passenger.)

Meta-Consideration: The Cost of Doing Analysis

A cartoon slide reminds us that sometimes the cost of conducting a detailed cost-benefit study itself can exceed its expected benefit. Economists call this the meta-cost problem. Practical implication: use analysis where decision stakes justify it.

Connections & Broader Implications

1. Foundation for supply-demand: producers compare marginal revenue to marginal cost; consumers compare marginal utility to price.
2. Public policy: cost-benefit analysis underlies project evaluation, environmental regulation, and health-care decisions.
3. Ethical dimension: marginal reasoning should not ignore distributional consequences or non-monetary values when they are significant.

Key Takeaways

• Marginal change = the incremental difference caused by one additional unit.
• Decision rule: MB > MC$$ ⇒ proceed; else refrain.
• Diminishing marginal utility ensures MB curves slope downward.
• Fixed vs variable costs: only variable (avoidable) costs matter for marginal decisions in the short run.
• Always weigh the benefit of analyzing against the cost of analysis itself.