Marginal Cost/Marginal Benefits Rational Decision Making Incentives

1. Marginal Cost/Marginal Benefits Rational Decision Making Incentives 1. Marginal = Additional - Extra - One More 2. Marginal benefit – the benefit or satisfaction a consumer gets from consuming one additional unit of a good or service Example: * You are craving pizza so you order a pizza and have it delivered to your house. It is already cut into 8 pieces. * You quickly eat the first slice because you are starving (or think you are starving) * That first slice of pizza brought about some benefit and satisfaction to you (No way to measure the benefit of happiness or satisfaction that a person gets)

2. 3. Utils/Utility - ((Economists use the word Utility – how much satisfaction or joy a good or service brings to a consumer)) a) measured in “utils” (eventually this could be dollars or units of a good) b) utils is just used by economists to so-call measure the happiness or satisfaction of a person (eating a slice of pizza may bring 1 person 5 utils and another person 20 utils – depends on the person and or preference)

3. 4. Example: We are going to say that eating one slice of pizza equals 10 utils (you could say that the Marginal benefit would be 10 utils)

4. Remember (Marginal means Additional) Marginal Cost – the cost to obtain or produce One additional unit of a good or service So remember: You paid for the whole pizza to be delivered to your house….All 8 slices arrived at one time Let’s say you paid 8 dollars for the pizza and delivery How much did the first slice of pizza cost you? If you said 8 you are correct..You had to pay 8 dollars to get the pizza to your door…..even the first bite of pizza cost 8 dollars Here is where the marginal costs comes in… “What will be the marginal cost of the second slice of pizza? Zero dollars..Its already at your house, on your counter..you don’t have to pay any additional money for it..the 2nd, 3rd, 4th, etc slices of pizza don’t cost any additional dollars..

5. Now we can start making some decisions..Rational Decision Making = occurs when the Marginal Benefit of an action equals or exceeds the Marginal Costs How does this relate to our pizza example?? How many slices of pizza should you eat at your house? Assume 1 util = 1 dollar worth of benefit The marginal cost of 1 slice of pizza is 8 dollars The marginal benefit of 1 slice of pizza is 10 utils (lets think of the 10 utils as 10 dollars)

6. So if 1 util equals 1 dollar then this person should definitely eat the first slice of pizza Why? because the Marginal Benefit is greater than the Marginal Cost Should this person consume the second slice of pizza? What is the Marginal Costs of the second slice of pizza? ZERO dollars What is the Marginal Benefit of the second slice of pizza? It can vary but it will definitely be less than 10 utils (Marginal Benefitdeclines over time and with increased consumption!!)

7. ((Have you ever eaten an entire large bag of chips or cookies or overindulged at Thanksgiving??? How did you feel afterwards? better than when you started or worse? Was that last chip or cookie as beneficial for you as the first one? No * The second slice of pizza is not as useful as the first because the consumer is a little less hungry now that they have consumed 1 slice This is called Diminishing Marginal Utility Still the person may get some real benefit from the second slice.. we will say 6 utils so the person should rationally eat the second slice of pizza

8. Should this person eat a 3rd slice of pizza? Again it depends Lets look at the numbers What is the Marginal Costs of the 3rd slice? Zero dollars .. its still sitting on the counter Lets assume the Marginal Benefit of the 3rd slice is 1 util It’s perfectly rational to consume the 3rd slice (the Marginal Benefit is greater than the Marginal Cost)

9. Should you go for the 4th slice? The Marginal Cost is still Zero But what happens to the Marginal Benefit on the 4th slice? Negative 1 Eating the 4th slice will actually cause this person some discomfort or guilt or some other negative consequence In Rational Terms, this consumer should not eat the 4th slice of pizza

10. So now the person is at the mall and must purchase the pizza by the slice This changes things: The pizza at the mall costs $2.49 and the only way to get it is by one slice at a time. The Marginal Cost of each slice is $2.49 The person should only consume 2 slices..Why? The Marginal Benefit is less than the Marginal Cost Remember: - marginal means “additional” -rational decisions are made using marginal costs and marginal benefits - marginal benefitsdecline with increasedconsumption

12. II. Incentives (Positive & Negative) Incentive: something that motivates or encourages someone to do something Positive Incentive: Incentives that are good, helpful, often a reward / reward people for making certain choices or behaving in a certain way (If you do this, then you will be rewarded this..)

13. Negative Incentive: Incentives that make people NOT want to do something / penalize people for making certain choices or behaving in a certain way These might mean making people pay money or fines Examples: Positive Incentive: golden tickets, when a store has a sale / free time / higher pay / higher grade * Positive Incentives make us feel happy Negative Incentive: speeding ticket / lose a privilege / something taken away * Negative Incentives make us feel sad