Question

Marginal analysis and decision-making:

Concept: The Fundamental Assumption of Economics

All social phenomena emerge from the actions and interactions of individuals who are choosing in response to expected marginal benefits and expected marginal costs to themselves.

• Definition: Marginal is additional or incremental (amount of increase) or decremental (amount of decrease).
• Should I do (choose) activity x?
• MC(x) = the additional costs of doing x
• MB(x) = the additional benefits of doing x

Rule:

• If Expected MB(x) > Expected MC(x), do x; otherwise don't.

Application:

Would an employer ever hire anyone if the additional cost of his or her employment were greater than the marginal/additional benefit? Of course not, to do so would be irrational.

Assumptions:

In economics, we assume rationality. No one would intentionally harm themselves.

Do businesses have the ability to measure costs? Marginal costs?

Comment

Answer 1

Yes, businesses have the ability to measure cost of their operations. This they do by using a cost function which is nothing but a function of input prices and input quantities, and output quantity. In this based on the price of the inputs (wage rate for labour and rent for capital), the cost is estimated for a given level of output.

By using differential calculus one can get the marginal cost (MC).

Using the marginal cost and equating it to either the marginal revenue or the price of the final commodity, a firm can determine the equilibrium level of output.