Cost–Benefit Analysis & Marginal Decision Rules

You’ll be able to

Apply the rule that a rational actor continues an activity while marginal benefit exceeds marginal cost
Explain why sunk costs are irrelevant to a forward-looking decision
Distinguish marginal from average and total quantities

Decisions are made at the margin

Economics almost never asks "should I do this?" It asks "should I do one more?" The marginal benefit (MB) is the additional benefit from one more unit; the marginal cost (MC) is the additional cost. The rule is to keep going while MB > MC and stop where MB = MC. This is not one topic among many — it is the same rule that will reappear as the profit-maximizing quantity, the optimal level of pollution abatement, and the utility-maximizing consumption bundle. Learning it once, properly, pays for itself repeatedly.

The optimum

continue while MB > MC · stop where MB = MC · you have gone too far when MB < MC

The optimum is where the *marginal* quantities are equal, never where total benefit is largest or average cost is lowest.

Sunk costs are gone

A sunk cost is a cost already incurred and unrecoverable. Because the decision rule compares additional benefit with additional cost, a sunk cost belongs to neither and must be ignored. Someone who sits through a film they are not enjoying because the ticket is paid has confused a spent cost with a forward-looking one. The economically relevant question is only whether the remaining hour is worth more than what else that hour could do. This feels wrong to most people, which is why the exam asks it.

Marginal, average and total are three different things

Confusing these produces wrong answers that look careful. Total is the running sum. Average is total divided by quantity. Marginal is the change from adding one unit — the difference between consecutive totals. Marginal can fall while average still rises, and total keeps growing as long as marginal is positive. Whenever a table gives you totals, the marginal column is the row-to-row difference, and that column is almost always what the question needs.

Worked example

A firm considers hiring workers. The marginal benefit of the first four workers is $100, $80, $60 and $40; each worker costs $50. How many should the firm hire, and what is the total surplus?

1.Worker 1: MB $100 > MC $50 — hire. Surplus $50.
2.Worker 2: MB $80 > MC $50 — hire. Surplus $30.
3.Worker 3: MB $60 > MC $50 — hire. Surplus $10.
4.Worker 4: MB $40 < MC $50 — do not hire; this worker would reduce surplus by $10.
5.Total surplus from three workers: $50 + $30 + $10.

Answer: Hire three workers, for a total surplus of $90. Note that hiring the fourth would still raise total benefit — but by less than it raises cost, which is what makes it the wrong call.

Watch out

Maximizing total benefit is not the goal. Total benefit keeps rising as long as marginal benefit is positive, well past the point where the extra units cost more than they are worth. The optimum is where MB meets MC, not where the total peaks.

Checkpoint

A student has spent $200 on a non-refundable course she is not enjoying. Deciding whether to keep attending, she should consider:

Checkpoint

A producer is at a quantity where marginal benefit is $30 and marginal cost is $45. To improve the outcome, the producer should:

Checkpoint

Total benefit rises from $180 at 5 units to $200 at 6 units. The marginal benefit of the sixth unit is:

On the exam

When a table of totals appears, write the marginal column in the margin before reading the question. Nearly every quantitative decision item is answered from that column, and computing it once beats recomputing differences under time pressure.

Answer the 3 checkpoints as you read.