Marginal Benefits, Costs, and Net Benefits

Opportunity Cost and Decisions An explicit cost is a cost that involves actually laying out money. An implicit cost does not require an outlay of money; it is measured by the value, in dollar terms, of the benefits that are forgone. (e.g., consider opportunity cost)

Opportunity Cost and Decisions

Accounting Profit Versus Economic Profit Accounting profit = business’s revenue minus – explicit costs – depreciation Economic profit = business’s revenue minus –explicit costs –Depreciation –opportunity cost of its resources Economic profit is usually less than accounting profit

Making ‘How Much’ Decisions: The Role of Marginal Analysis

Marginal Benefit Marginal benefit: the additional benefit derived from one more unit of an activity Decreasing marginal benefit: when each additional unit of an activity produces less benefit than the previous one. (Think donuts!) Marginal benefit curve: shows benefit of each additional unit (Hint: wouldn’t this curve look suspiciously like the demand curve? Ahh… now you’re thinking ahead!)

Marginal Cost Imagine a pizza restaurant, like Jalino’s that used to be across the street Marginal costs include costs for sauce, dough, toppings, energy At first, marginal cost falls as producing becomes more efficient (efficient labor use, buying in bulk, many pizzas in the same oven) Then producing gets less efficient with existing kitchen, staff, capital – and more marginal cost rises

Marginal Cost Marginal cost = additional cost incurred by doing one more unit of an activity buying one more banana producing one more latte Increasing marginal cost: when each additional unit costs more than the previous unit Marginal cost curve shows the cost each additional unit of an activity

Marginal Analysis The optimal quantity of an activity is the level that generates the maximum possible total net gain. MB = MC The principle of marginal analysis says that the optimal quantity of an activity is the quantity at which marginal benefit is equal to marginal cost.

The Optimal Quantity The optimal quantity of an activity is the quantity at which the marginal benefit curve and the marginal cost curve intersect.

Deadweight Loss Deadweight Loss: amount of benefit given up by failing to operate where marginal benefit equals marginal cost

Net Benefit Net Benefit: Total Benefits minus total costs minus deadweight loss