1. The importance of marginalism
Costs and Benefits
The importance of marginalism

2. Maximizing net benefit
Slogans:
“Greatest good of the greatest number”
“Do it if the benefits outweigh the costs”
“Maximize benefits and minimize costs”
Are imprecise guides to economic decisions whose goal is to maximize economic surplus or net benefit.

3. Comparing costs and benefits
Net benefit = Total Benefits - Total Costs
To maximize NET benefits, find the level of an activity at which
MARGINAL COSTS = MARGINAL BENEFITS (or as close to equality as the problem permits)

4. MC = MB leads to UNIQUE solution
Marginal costs = marginal benefits will lead to the unique optimal decision.
Total Benefit > Total Cost will NOT lead to a unique solution. Since both benefits and costs will normally rise with the level of an activity, many possible levels have total benefits greater than total costs.
But since marginal costs normally rise and marginal benefits normal decline, there will be one level of an activity at which MC = MB.

5. MC = MB is easy to apply
Marginal costs = marginal benefits can be applied more easily than any other rule.
Maximizing Total Benefit - Total Cost by exhaustive calculation requires knowing all the costs and benefits before taking any decision. Outside of textbooks, we rarely know this.
The equimarginal principle can be applied in stages: if MB > MC at a given level of activity, increase the activity; if MB < MC, decrease the activity; if MB = MC, stop.

6. Umbrellas and utility http://www.geocities.com/oldiesgg/singingin.mid
Click above for the title song

7. Example: how many umbrellas
Example: how many umbrellas? (umbrellas cost $5 each; declining marginal benefit)
Umbrellas
Tot.Benefit
Tot.Cost
Surplus 1 40 5 2 60 10 3 75 15 4 85 20 90 25 6 93 30

8. Total benefits and costs -- graphically
100 80 60 40 20
Umbrellas

9. Total benefits – diminishing marginal returns
100 80 60 40 20
Umbrellas

10. Total costs in blue -- $ 5 per umbrella
Benefits and Costs
Note that total benefits are ALWAYS greater than total costs.
100 80 60 40 20
Total costs rise linearly with quantity –
5 umbrellas cost $ 25
Umbrellas

11. Example: how many umbrellas
Example: how many umbrellas? (direct computation eventually leads to the answer: you maximize surplus with 4 or 5 umbrellas )
Umbrellas
Tot.Benefit
Tot.Cost
Surplus 1 40 5 35 2 60 10 50 3 75 15 4 85 20 65 90 25
65 ** 6 93 30 63

12. Example: how many umbrellas
Example: how many umbrellas? (computing MARGINAL BENEFIT leads to the same answer as computing all net benefits)
Umbrellas
Tot.Benefit
M.Benefit
MB ?? MC
-----
---- 1 40
MB > MC 2 60 20 3 75 15 4 85 10 5 90
MB = MC ** 6 93
MB < MC

13. MARGINAL = ADDITIONAL
In the last table, MARGINAL BENEFIT was computed as the difference between the benefit resulting from an additional umbrella and the benefit without the additional umbrella.
For example, MB at 4 umbrellas is equal to Total Benefit at 4 minus Total Benefit at 3 or 85 – 75 = 10.

14. Marginal benefits and costs -- graphically40 35 30 25 20 15 10 5
MB = MC
Marginal cost = $ 5
Umbrellas

15. Advantages of marginalism
Step-by-step procedure: even if we did not know all the costs and benefits, we can take another step (increase the level of activity) as long as MB > MC. “How much would you be willing to pay for 5 umbrellas?” is a hard question to answer; “How much would you pay for another umbrella?” is an easier question to answer.
Faster “what-if?” recalculations. What if the price of umbrellas were $8? $15? Using the “total benefit” method requires every calculation to be repeated; but we could read the result quickly from the marginal table.

16. Tomatoes and Diminishing Marginal Returns

17. Example: how much compost
Example: how much compost ? (cost of compost 50 cents per pound; price of tomatoes 30 cents per pound)
Compost
Tomatoes
M.Product
MB = Price times MP
100 1
120 20
$ 6.00 2
125 5
$ 1.50 3
128
$ 0.90 4
130
$ 0.60
131
$ 0.30 6
131.5
0.5
$ 0.15

18. Tomatoes and compost
What if the price of compost rises to $ 1.00 a pound? (answer: buy 2 pounds)
What if the price of tomatoes rises to 60 cents a pound (with compost at 50 cents)? Multiply marginal product by $0.60 to get a new “marginal benefit” column; compare to the price of compost.
Compute the net benefit in the original case and the above two problems to satisfy yourself that the MB = MC rule will maximize net benefit in all cases.

19. Example: how much compost
Example: how much compost ? (cost of compost 50 cents per pound; price of tomatoes $ 0.60 per pound)
Compost
Tomatoes
M.Product
MB = Price times MP
100 1
120 20
$ 12.00 2
125 5 $ 3
128 $ 4
130 $
131 $ 6
131.5
0.5 $

20. Marginal benefits and costs -- graphically
3.00
2.00
1.00
0.50
MB = MC at between 5 and 6 pounds of compost
Marginal cost = 50 cents
Fertilizer