Marginal Analysis

Read this article to learn about one of the fundamental terms in economics: marginal analysis. Specifically, understand the concept of marginal benefit and marginal cost and what is meant in economics when we say that individuals make rational choices at the margin. Also, complete the problems in the "Try It" box and check your answers.

Marginal Cost

Figure 1. Charm Bracelet. What is the marginal cost of getting more silver heart charms? Should you buy just one charm for $4, or all of them for$12?

Generally speaking, marginal cost is the difference (or change) in cost of a different choice. From a consumer's point of view, marginal cost is the additional cost of one more item purchased. From a business's point of view, marginal cost is the additional cost of one more item produced.

Suppose you typically spend a week at the beach for vacation, but this year you earned an annual bonus from your job. Should you rent a beach house for one week or two? A one-week rental costs $2,000. A two-week rental costs$3,600. Holding everything else constant, which option is better? If you stay for two weeks, the cost is significantly higher: $3,600 versus$2,000. But consider the cost by week. The first week costs $2,000. The difference in cost between one week and two is$3,600 – $2,000, or$1,600. Thus, while the marginal cost of the first week's rental is $2,000, the marginal cost of the second week's rental is$1,600. This illustrates the key rule of marginal analysis: Marginal cost = the change in total cost from one option to another.

Consider another example. Imagine that you're out getting ice cream with your friends or family. You can choose whether to buy one, two, or three scoops of ice cream. One scoop costs $3.00, two scoops cost$5.00, and three scoops cost $7.00. This information is shown in the following table.  Scoops of Ice Cream 1 2 3 Total Cost$3 $5$7

What is the marginal cost of each scoop of ice cream? The marginal cost of the first scoop of ice cream is $3.00 because you have to pay$3.00 more to get one scoop of ice cream than you do to get zero scoops of ice cream. The marginal cost of the second scoop of ice cream is $2.00 because you only need to pay two more dollars to get two scoops than you need to pay to get one scoop. The marginal cost of the third scoop is also$2.00 because you would need to pay an additional two dollars to get that third scoop.

 Scoops of Ice Cream 1 2 3 Marginal Cost $3$2 \$2

Marginal costs sometimes go up and sometimes go down, but to get the clearest view of your options, you should always try to make decisions based on marginal costs, rather than total costs.