Cost-Benefit

Rational Decisions  Due to scarcity, Every decision involves an opportunity cost.

 Economists assume that people make rational decisions.

 We get something we want, but we give up something else.

Rational Decisions

 We weigh the benefits and cost of each option.

 “Cost-benefit analysis” is when we choose the option whose benefits (in your opinion) outweigh its cost.

Rational Decisions Marginal Benefit/Marginal Cost

 Marginal Benefit – Extra amount gained when a choice is made.

 Marginal cost refers to the value of what is given up in order to produce that additional unit. Extra amount given up when a choice is made (could be the same as opportunity cost).

 Additional units of a good should be produced as long as marginal benefit exceeds marginal cost.  It would be inefficient to produce goods when the marginal benefit is less than the marginal cost. Therefore an efficient level of product is achieved when marginal benefit is equal to marginal cost.

Marginal Benefit and Marginal Cost

Many decisions are not either/or choices .

If you like popcorn and soda, you don’t always have to choose between buying one or the other.

You might need to decide how much of each item you can buy for a certain price in order to gain the greatest total benefit, or satisfaction.

Example:

 Cost of bag of popcorn and cost of can of soda are the same  The first bag of popcorn you purchase will give you a lot of satisfaction  If you buy a second bag of popcorn, it will taste good, but it is not as pleasing as the first bag.

 The additional pleasure, or Marginal Benefit, you would gain from it would be less than the first bag

Marginal Benefit/Marginal Cost

 If you were going to spend more money, you would probably be more satisfied by buying a can of soda for the same amount of money as the second bag of popcorn.

 The first can of soda would give you a greater marginal benefit for the additional money you are spending, which is called your Marginal Cost.

Marginal Benefit/Marginal Cost

 When the marginal benefits you receive from a decision are equal to or greater than the marginal costs of making that choice, you are making a rational decision.

The Production Possibilities Curve

The graph Economists use to show what combination of two products is possible with a given amount of resources.

The Production Possibilities Curve

 Companies that make and sell products also need to make rational decisions, in order to make a profit and stay in business.

 Producers use their own version of cost-benefit analysis to decide what combination of things they should make to earn the highest possible profit, using their limited resources.

The Production Possibilities Curve

 Like buyers, sellers must weigh marginal benefits and marginal costs.  A farmer grows corn and soybeans. If he can afford to hire ten workers, but he uses them all in his corn field, he is wasting his labor resources.

 For the same labor cost, he could move some of the ten workers to his soybean field

The Production Possibilities Curve

 If farmer moves a few of workers, he would achieve a big marginal benefit in soybean production, while causing only a small decline in his corn production.

 He would be operating more “efficiently” to use his resources to achieve greater overall production without increasing his costs.

Thinking It Through

 What is a rational economic decision?

 A. One in which there are no opportunity costs  B. One in which benefits are unknown, but costs are low  C. One in which marginal benefits are greater than marginal costs  D. One in which marginal costs are greater than marginal benefits

Show what you know:

 Most people would rather order one hamburger and one order of French fires, rather than two hamburgers and no French fries. Explain why economists consider this an example of rational decision making

 Come up with the name of country  List 2 products  Draw the curve  Label 3 points on the Production Possibilities Frontier (A,B,C)  Show 1 unattainable point and 1 point that is inefficient  Explain what the opportunity cost of moving from one point to another would be.

 EX: The opportunity cost of producing 100 units of butter is the 30 guns given up.