Marginalism Effective decision making requires comparing the additional costs with additional benefits. Most choices involve doing a little more or a little less of something – few choices are all or nothing.

Standard correlation SSEF2 The student will give examples of how rational decision making entails comparing the marginal benefits and the marginal costs of an action. b. Explain that rational decisions occur when the marginal benefits of an action equal or exceed the marginal costs.

Marginalism Choices are rarely all or nothing – usually deal with incremental changes Marginal = Extra Marginal cost – the extra cost associated with producing one additional unit. Marginal benefit – the extra output or change in total benefit caused by producing one additional unit

Choices made on Margin – they all have clear marginal costs and benefits to compare Should a consumer buy a bit more of this and a bit less of that? Spend more on car payment, less on entertainment? Should a firm produce a few more or a few less units of output? Should the gov’t increase taxes to hire a few more teachers so class size will decrease? Are the additional revenues generated by hiring another worker equal to or greater than the additional cost?

More benefit? Go for it As long as the marginal benefit of an activity exceeds the marginal cost, people are better off doing more of it. When marginal cost exceeds marginal benefit, they are better off doing less of it. A rational decision involves choosing the choice where marginal benefits exceeds marginal costs.

Marginal Utility Additional satisfaction gained with each additional unit consumed Marginal = extra Utility = satisfaction

Law of Diminishing Marginal Utility Marginal utility is greatest with the first unit consumed. After that, each unit consumed produces less satisfaction. Example – you are starving and you order a pizza – the first slice will have the most utility (satisfaction) – after that you will be more full, and the second slice won’t produce as much satisfaction. The third slice won’t be as good as the second, because you are becoming full. At some point you will stop eating because you no longer gain utility from the pizza. http://www.youtube.com/user/mjmfoodie#p/u/28/KOUJEyy48qY

Diminishing Marginal Utility People stop buying an item when the value of the satisfaction from the next unit of the same items becomes less than the price they paid for it. Both price and marginal utility are important in determining how many units are produced. What other examples can you think of?

Law of Diminishing Returns When one factor of production (labor) is increased, while other factors (capital) are held constant, the resulting increase in output will level-off after some time and then decline. Although the marginal productivity of the workforce decreases as output increases, diminishing returns do not mean negative returns until the number of worker exceeds the available machines or workspace. In every experience this law is expressed as “the pain is not worth the gain.”

15 $45.00 # of workers Marginal Product 1 20 $40.00 2 50 30 $90.00 3 Rolls of tape Marginal Product Value of additional rolls $3.00 Marginal cost of labor $40.00 1 20 $40.00 2 50 30 $90.00 3 70 $60.00 4 85 15 $45.00 5 95 10 $30.00 6 100 $15.00 2 – 30, 90, 3 – 20, 60 4 – 85, 15 5 – 10, 30 6 – 5, 15

How many to buy? You have received $75 as a birthday gift and plan to buy a pair of jeans. When you go shopping, you discover the store is have a super sale on your brand and style of jeans for $15 a pair. How many pairs would you buy and why? Use what you have learned about diminishing marginal utility to explain your answer.