Micro CHAPTER 1.5:

CHAPTER SUMMARY

Decisions have both explicit (direct) and implicit (indirect/opportunity cost) costs. When we make decisions, we have to do a cost-benefit analysis, ensuring that the benefits of a decision are greater than the costs.

When economists look at decisions to buy something, we look at decisions on the margin. The marginal (mar-ji-null) effect of something is the effect of adding one more. For example, imagine that I am so hungry that a sandwich would give me $15 worth of utility (satisfaction) right now. At the restaurant near my house, that sandwich costs $5. My marginal benefit of getting one sandwich would be $15, and my marginal cost to buy it would be $5. My marginal net benefit (net = benefit - cost) would be $15 - $5 = $10.

After eating that sandwich, though, I feel a bit better, but still hungry. Buying a second sandwich would bring me $7 of marginal benefit and cost another $5, so my marginal net benefit of buying a second sandwich would be $2. Since I have a marginal net benefit, I should buy it.

Okay, now I'm really full. Eating a third sandwich would only give me a marginal benefit of $1 because I'm really not that hungry any more, but the marginal cost of the third sandwich is still $5. In this case, my marginal net benefit would be -$4, so I should not buy the third sandwich. A fourth sandwich would probably make me throw up, so it would have a marginal benefit of -$10, meaning the net marginal benefit would be -$15.

From this example, we can see the effect of the law of diminishing (shrinking) marginal utility. This is the idea that, the more I get of something, the less utility I receive. For example, winning $2 million dollars would be more exciting than winning $1 million dollars, but it would not be twice as exciting.

You can see this all in the chart below:

The "big idea" here is that rational (ra-shi-null [logical]) people will stop buying things once their marginal cost is greater than their marginal benefit. A rational person would buy 2 sandwiches because they would both bring positive net marginal benefit, but would stop there because they would get a negative net marginal benefit from the 3rd sandwich onward. We always focus on the margin.

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