The Marginal Decision Rule
In this unit, we examine the process individuals and companies use to make decisions. We start with the basic assumption that market participants are driven by rational self-interest – individuals maximize their satisfaction (or utility) while companies maximize their profits.
According to the marginal decision rule, individuals and companies compare the marginal benefit or marginal cost of adding another unit to consumption or production. If the marginal benefit of the next unit exceeds the marginal cost, they should add more units.
The Benefits and Costs of Studying Economics
Review the optimal decision rule in:
Consumer and Producer Surplus
We can illustrate marginal benefit and marginal cost through the demand and supply curves. Consumer surplus illustrates the net benefit a buyer receives when they buy something for a price that is lower than the value they place on it.
For example, a happy restaurant patron might think, "I got a real bargain tonight, since I would have paid much more money for that delicious meal". Similarly, a producer surplus describes how a company profits when it is able to sell something for a price that is higher than what it cost to produce it.
The free market equilibrium represents the optimal and most efficient point in the market. Review our discussion of the demand and supply curves in the previous unit.
Review consumer and producer surplus in the following resources. Take the quiz in the last link to test your knowledge.
The free-market equilibrium is the most efficient point in the market in terms of optimizing total surplus. However, from a society's point of view, the market equilibrium is not always best, depending on what you value and are interested in achieving in your community.
Sometimes externalities, asymmetric information, and market power generate additional costs or benefits that were not part of your initial analysis of consumer demand, producer supply, or cost curves.
Review market failure in:
There is a common saying that income inequality causes "the rich to become richer and the poor to become poorer". Review income inequality and workplace discrimination in Inequality, Poverty, and Discrimination.