ECON101 Study Guide

Unit 3: Markets and Individual Maximizing Behavior

3a. Identify the maximizing behavior of individuals in the market

The Marginal Decision Rule

  • Define net benefit.
  • Define marginal benefit and marginal cost.
  • Define the marginal decision rule.
  • What steps do economic agents follow to determine optimal outcomes?
  • What is the value of marginal benefit, with respect to marginal cost at the optimal level of consumption or production?

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

  • What is the graphical representation of consumer surplus?
  • What is the graphical representation of producer surplus?
  • How does demand represent marginal benefit and how does supply represent marginal cost?
  • How do we analyze market outcomes that optimize how much a society benefits from a sale or purchase, in terms of the total surplus in the market?

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.


3b. Identify the behavior of individuals when markets fail

  • Name some examples of market failure.
  • Define and list some examples of deadweight loss.
  • Define and list some examples of a public good.
  • Define and list some examples of a free rider.
  • Define and list some examples of a negative externality.
  • Define and list some examples of a positive externality.
  • What government policies are used to correct negative externalities?
  • Define the concept of the tragedy of the commons.

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:


3c. Analyze the causes and reasons for income inequality

  • Define income inequality and name some steps communities and governments have taken to alleviate it.
  • Is the market always fair? Why do some societal groups often experience a higher concentration of poverty?
  • Name some government programs aimed to help those in need and reduce poverty levels.
  • Define discrimination and name some examples of discrimination in the workplace.
  • Name some examples of some steps governments have taken to reduce or eliminate discrimination in the workplace?
  • Review the topic of discrimination that is banned in the workplace.

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.


Unit 3 Vocabulary

  • Consumer surplus
  • Deadweight loss
  • Discrimination
  • Equilibrium
  • Free rider
  • Income inequality
  • Marginal benefit
  • Marginal cost
  • Marginal decision rule
  • Market failure
  • Negative externality
  • Net benefit
  • Positive externality
  • Producer surplus
  • Public good
  • Tragedy of the commons