Marginal Analysis: Study with Video Lessons, Practice Problems & Examples

In economics, marginal analysis is crucial for decision-making, focusing on the additional benefits and costs of consuming one more unit of a good. The key equation is marginal benefit=marginal cost, guiding optimal consumption levels. For example, when eating pizza, the marginal benefit decreases with each slice, while marginal costs may include emotional or health considerations. Understanding this balance helps identify the point of allocative efficiency, where satisfaction is maximized without incurring unnecessary costs.

Marginal Analysis

So let's move on to the last key economic idea here. To make the best decisions, we use marginal analysis. So that sounds like a kind of a funky term, but in economics, marginal just means extra or additional. Right? Like the idea of one more. Right? What is one more? How is it going to change our current situation? Like what happens if we produce one more unit? What happens if I eat one more slice of pizza, things like that. So I hope you notice this big green box because I was trying to catch your eye with it. And inside, we've got a key formula that we're going to use throughout the entire class. I'm going to introduce you to it now. It's the idea that marginal benefit equals marginal cost. Okay. We're going to define those terms in a second, but I just wanted to point out how important this is for the class. It's going to help us in all sorts of calculations and it's going to be a key point on a lot of graphs. We're going to use it when we're defining allocative efficiency. Right now I'll have an example for you with optimum consumption, like how much we should consume, right, the optimum amount to consume, or finding the profit maximizing point in different business structures. How do we make the most profit? All of these are related to the marginal benefit equalling the marginal cost, and I promise it's going to come up quite a bit in this course. So let's define those terms. And even before we get to the graph here and you're like woah woah woah woah woah woah woah woah woah woah Brian, I haven't seen a graph since high school, man. I don't know what you're about to do, but it's scaring me. I feel your pain and we're going to have a graphing review at the end of this section. That's going to kind of be a refresher for you. It's not going to go so deep, but it is going to help you have the tools, ready to do really well in this course. So when we get to the graph, I'm going to use blue for our marginal benefit, and let's go ahead and define marginal benefit right now. When we think of marginal benefit, it's remember marginal is additional. Right? So it's kind of like the additional satisfaction that we get from something. It's really hard, you know, it's a subjective kind of thing, it's pretty qualitative. It's not so easy to just define how much happiness, you know, does going to the movies bring me. Oh, it brings me 10 happiness. Right? It's not so easy. But in this class, you know, they kinda quantify it in that sense, and, most of the time, it's just going to be given to you. You can't really be expected to know how to define these benefits in number terms. Right? So we're gonna kinda call marginal benefit here. We'll say it's the additional satisfaction. Right? Additional satisfaction that you're getting from one more of something. Right? And in our example, we're going to be talking about pizza. So it's the additional satisfaction from eating one more slice of pizza. Right, and for cost we're going to be using red. And I guess I'll take this moment to point out that in this class we're going to be using a lot of colors especially when it comes to graphs, and I really suggest that you do the same thing. Even on the exams, I would suggest bringing a couple of different color pens. It just makes it so much easier, to keep your work separate and just keep track of everything. I really suggest using at least 2 colors, maybe even 3 when you're taking this class. So we're going to use red for marginal cost, and this is basically well, it's the additional cost. Right? I'm using cost again, but it doesn't have to be a monetary cost. Right? It could be a cost, an emotional cost, a psychological cost, could even be like a time cost, right? The time you spend doing something is part of the cost. So I'm just going to put additional cost here. It's a little easier to understand than marginal benefit. And let's go ahead and dive into the graph. Okay. I'm not going to use so many numbers here. We're just going to use the graph as a tool. So let's start with our marginal benefit, and let's think about eating slices of pepperoni pizza. Right. The goal here is to find out what is the optimum amount of pizza that I should eat. So, you know, it's almost lunchtime here and man that first slice of pizza is sounding really good right now. I'm pretty hungry, and I think that if I were to eat a slice of pizza right now, probably bring me quite a bit of happiness. I'm just going to put it way up here. No numbers, right? We're just saying that there's a lot of happiness, with that first slice of pizza. And the second slice, yeah, you know, still sounds delicious, still sounds cheesy, and oh, yeah. That sounds good, but that first bite that I got from that first slice of pizza, I'm not getting it back again, right? I'm still eating delicious pizza but that first slice was extra delicious. So it's still bringing me quite a bit of happiness but not as much as that first slice. The third slice, I'm still hungry, still feeling pretty good. I'm going to eat another slice of pizza and I'm still going to feel pretty good about it. By that 4th slice, well, now I'm getting full. But, I was still hungry so, you know, still bringing me happiness so it seems okay. How about once I get to that 5th slice of pizza? Now, you know, I'm starting to, like, question myself. I don't know if I should be eating this much pizza at once, but, you know, if I did it anyways, I'd probably still get some benefit from it. Maybe, you know, even if it's like, I'm not going to starve today, right, or tomorrow I guess if I eat 5 slices of pizza. And by the 6th pizza, you know, I'm not getting much happiness out of it at all. It's just a lot of pizza at this point. So now let's talk about the marginal emotional benefits and delicious, we're just going to talk about like emotional benefits and emotional costs here, right? Psychological or like you know nutritional costs, nothing monetary. So that first slice of pizza, I'm really hungry. There's not a high cost here. I'm hungry. I want the pizza, so there's not really much cost. How about that second slice? Well I'm not as hungry anymore and now I might start thinking about my health, right? The 3rd slice, it's starting to come up. 4th slice. Now I'm not even hungry anymore. Right? I ate that that 4th slice of pizza, and now I feel satiated. That 5th slice of pizza, it's going to come at a cost. Right? Now I'm bloated. Right? I can't even, like, get up after lunch. I'm going to need a 30 minute break. Probably, you know, it's a little much. And that 6 piece slice of pizza now I'm just, you know, I'm, I just got a stomachache now. It just wasn't worth it. Right? So the idea I think you might see at this 4th slice of pizza, they're kinda overlapping here, but But the idea I think you'll see what's going to be happening here. Why don't we go ahead and connect our lines? So here, we're going to have what's called the marginal benefit line. Right? And let's draw our marginal cost line this way. And you can see that the marginal cost is increasing the more pizza I eat. Okay? So what do we find here? I think it's pretty obvious on the graph that there's one point that stands out right here in the middle, and that is when our marginal benefit equals our marginal cost. And just like we defined right up here, marginal benefit equals marginal cost at our optimum consumption. Right? So here at 4 slices of pizza, that is how much pizza I should eat and I'll be most satisfied. So let's think about some different situations. What if I had only eaten 3 slices of pizza? What would have happened? Right. Let's say I'm at this point right here, I ate 3 slices of pizza. Well, you can see that the marginal benefit at 3 slices of pizza, if I were to eat one more, I'd be bringing in you know still some happiness, right? I'm still hungry and the marginal cost is still down here. It's less than the marginal benefit. So the idea is I should keep eating pizza because the marginal benefit is greater than the marginal cost of that next slice of pizza. So when I have 3 slices of pizza, I should have another one. But what if I'm here at 5 slices of pizza? Right, that 5th slice of pizza, now the marginal cost is greater than the marginal benefit. I'm not even hungry anymore, I'm starting to question myself right like why am I eating so much pizza, and I find that that's too much pizza. So for me, right here, we're going to find that 4 slices of pizza is the correct amount, and, you know what you could think is like, you know, maybe for you, 4 isn't the right amount. Maybe you love pizza even more than I do, which I'm going to have to fight you on that. That's going to be difficult, but it's possible that maybe you want 5 slices of pizza, 6 slices of pizza, your marginal benefit might not decrease as fast as mine based on how much pizza you eat. Right? So the point here is that everyone's curve is going to be a little different. Mine happens to find that 4 slices is the optimum amount which actually to me might sound like a little much now, but the idea is that everyone's going to have their optimum amount of pizza. Alright? So why don't we move on to the next video?

Here’s what students ask on this topic:

What is marginal analysis in economics?

Marginal analysis in economics is a decision-making tool that examines the additional benefits and costs of consuming or producing one more unit of a good or service. The key concept is to compare the marginal benefit (MB) and the marginal cost (MC) of an action. The optimal decision is made when MB equals MC, ensuring that resources are allocated efficiently. This approach helps in determining the point of allocative efficiency, where satisfaction is maximized without incurring unnecessary costs.

How do you calculate marginal benefit and marginal cost?

Marginal benefit (MB) is the additional satisfaction or utility gained from consuming one more unit of a good or service. Marginal cost (MC) is the additional cost incurred from producing one more unit. To calculate MB and MC, you can use the following formulas:

$\mathrm{MB}=\Delta \mathrm{TB}\Delta Q$

$\mathrm{MC}=\Delta \mathrm{TC}\Delta Q$

Where ΔTB is the change in total benefit, ΔTC is the change in total cost, and ΔQ is the change in quantity. The optimal consumption or production level is where MB equals MC.

What is the significance of the equation marginal benefit equals marginal cost?

The equation marginal benefit (MB) equals marginal cost (MC) is significant because it represents the point of optimal decision-making in economics. When MB equals MC, resources are allocated efficiently, maximizing satisfaction without incurring unnecessary costs. This balance helps in determining the optimal level of consumption or production, ensuring that the benefits of an additional unit are exactly equal to the costs. This concept is crucial for understanding allocative efficiency and making informed economic decisions.

Can you provide an example of marginal analysis in everyday life?

Sure! Consider the example of eating pizza. The first slice provides a high level of satisfaction (marginal benefit), but as you eat more slices, the additional satisfaction decreases. Meanwhile, the marginal cost, such as feeling full or health concerns, increases. Using marginal analysis, you would continue eating until the marginal benefit of the next slice equals the marginal cost. If the fourth slice is where MB equals MC, that is your optimal consumption point, ensuring maximum satisfaction without unnecessary costs.

How does marginal analysis help in business decision-making?

Marginal analysis helps businesses make informed decisions by comparing the additional benefits and costs of producing one more unit of a good or service. By identifying the point where marginal benefit equals marginal cost, businesses can determine the optimal production level to maximize profit. This approach aids in resource allocation, pricing strategies, and understanding consumer behavior, ultimately leading to more efficient and profitable operations.