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Decision Making

Decision-making using marginal analysis

People make economic decisions everyday.   As a consumer you have to decide how to spend your limited money income on goods and services.   As a consumer you also have to decide whether you will spend all of your income on goods and services or save some of your income to finance consumption in the future.   As a labor resource you have to decide if you are going to spend your time working for pay, sleeping, or engaging in leisure activities.   Also, as a resource you have to decide how much education or training will maximize your lifetime earnings.   If you are an entrepreneur, then you have to decide how many people to hire, how much you are going to produce, what price to charge, or how much to invest in new plant or equipment.

All economic decisions yield benefits to and impose costs on the decision-maker.   The rational decision-maker must therefore analyze the benefits and costs of each decision.   Initially, you may think that a wise decision occurs if the total benefits associated with a decision exceed the total costs.   However, this approach fails to recognize the goal of economic choice.   Remember the goal of economic choice is to get the greatest value from resources.   To accomplish this goal, you want to evaluate the difference in the total benefits and total costs of an activity.   If total benefits exceed total costs for at least some levels of the activity, you want to maximize the net benefits.   If the total costs exceed total benefits for all levels of the activity, then you want to minimize net losses.

Net benefits are maximized or net losses are minimized when the decision maker follows a simple rule.   Continue engaging in an activity as long as the marginal benefit is greater than or equal to the marginal cost.   With one exception discussed later, the optimal decision occurs when the marginal benefit equals the marginal cost as long as this equality exists.   Marginal analysis enables people to get the...