1. 251FINA Chapter Two Dr. Heitham Al-Hajieh

2. Marginal analysis
Marginal benefit = additional benefit resulting from a one-unit increase in the level of an activity
Marginal cost = additional cost associated with one-unit increase in the level of an activity

3. Net benefit
Individuals are not expected to maximize benefit; nor are they expected to minimize costs.
Individuals are assumed to attempt to maximize the level of net benefit (total benefit minus total cost) from any activity in which they are engaged.

4. Marginal analysis MB > MC  expand the activity
MB < MC  contract the activity
optimal level of activity: MB = MC (Net benefit is maximized at this point)

5. Marginal benefit
MB generally declines as the level of an activity rises, ceteris paribus.
Consider the MB of time spent studying:

6. Marginal cost
For most activities, marginal cost rises as the level of the activity increases.

7. Optimal study time
The optimal amount of study time occurs at the point at which MB = MC

8. Production possibilities curve
Assumptions:
A fixed quantity and quality of available resources
A fixed level of technology
Efficient production (i.e., no unemployment and no underemployment)

9. Example: study time
4 hours left to study for two exams: economics and calculus
Output = grades on each exam
Fixed resources?
Fixed technology?
No unemployed nor underemployed resources?

10. Alternative uses of time

11. Law of diminishing returns
Law of diminishing returns: output will ultimately increase by progressively smaller amounts when the use of a variable input increases while other inputs are held constant.
Does this apply in this example? What are the fixed inputs?

12. Production possibilities curve

13. Marginal opportunity cost
Marginal opportunity cost = the amount of another good that must be given up to produce one more unit of a good.

14. Calculating marginal opportunity cost
In the interval between points A and B, the marginal opportunity cost of 1 point on the economics exam is 1/3 of a point on the calculus exam.

15. Marginal Opportunity Cost (continued)
In the interval between points B and C, the marginal opportunity cost of one point on the economics exam equals 4/3 of a point on the calculus exam.