Consumer Behaviour: Marginal Analysis

• Opportunity Cost,

• Marginal Analysis,

• Rationalism
 Opportunity Cost
Opportunity Cost :
Opportunity cost is the benefit forgone from the alternative that is not
selected. Opportunity cost can be defined as the cost of any decision
measured in terms of the next best alternative, which has been
sacrificed.
To illustrate the concept better, let us assume that a person who has
TK. 500 at his disposal can spend it on either of the three options:
a) having a dinner at a restaurant,
b) going for a music concert or
c) for a movie.
The person prefers going for a dinner rather than to the movie, and the
movie over the music concert. Hence, his opportunity cost is sacrificing
the movie, the next best alternative once he goes for a dinner.

If we carry forward the same example at the firm level, a manager

planning to hire a stenographer may have to give up the idea of having
an additional clerk in the accounts department.
This is applicable even at the national level where the country allocates
higher defense expenditures in the budget at the cost of using the
same money for infrastructural projects. In order to maximize the value
of the firm, a manager must view costs from this perspective
 Marginalism
If resources at disposal of a manager are scarce, he has to be careful
about the utilization of each and every additional unit of resources. In
order to decide on the use of an additional man-hour or machine-hour,
he needs to know what is the additional output expected there from.
Similarly, a decision about additional investment has to be taken in
view of the additional return from that investment. The term ‘marginal’
is relevant for all such additional magnitudes of output or return .
 Marginal Analysis
Marginal value
The marginal value of a dependent variable is the change in this
dependent variable associated with a 1-unit change in a particular
independent variable
Marginal Analysis
Marginal analysis is used to assist people in allocating their scarce
resources to maximize the benefit of the output produced. Simply
getting the most value for the resources used.
 Marginal Analysis

Marginal analysis: The analysis of the benefits and costs of the marginal
unit of a good or input.
(Marginal = the next unit)
A technique widely used in business decision-making and ties together
much of economic thought. In any situation, people want to maximize
net benefits:
• Net Benefits = Total Benefits - Total Costs
 Control Variable
To do marginal analysis, we can change a variable, such as the:

• quantity of a good you buy,

• the quantity of output you produce, or

• the quantity of an input you use.

This variable is called the control variable .

Marginal analysis focuses upon whether the control variable should be

increased by one more unit or not.
 Key Procedure for Using Marginal Analysis

1. Identify the control variable (cv).

2. Determine what the increase in total benefits would be if one more
unit of the control variable were added.
This is the marginal benefit of the added unit.
3. Determine what the increase in total cost would be if one more unit
of the control variable were added.
This is the marginal cost of the added unit.
4. If the unit's marginal benefit exceeds (or equals) its marginal cost, it
should be added.
Key Procedure for Using Marginal Analysis
Look only at the changes in total benefits and total costs. If a particular
cost or benefit does not change, we just IGNORE IT !
As because:
Marginal Benefit = Increase in Total Benefits per unit of control variable
 TR /  Qcv = MR
where cv = control variable
Marginal Cost = Increase in Total Costs per unit of control variable
 TC /  Qcv = MC
So:
Change in Net Benefits = Marginal Benefit - Marginal Cost

When marginal benefits exceed marginal cost, net benefits go up.

So the marginal unit of the control variable should be added.

Example : Should a firm produce more?
• A firm's net benefit of being in business is PROFIT.

The following equation calculates profit:

PROFIT = TOTAL REVENUE - TOTAL COST

Where: TR = ( Poutput X Qoutput )

TC = σ𝒏𝒊=𝟏 (P𝒊𝒏𝒑𝒖𝒕 X Qinput )

Assume the firm's control variable is the output it produces.

Maximization occurs when marginal switches from
positive to negative.

• If marginal is above average, average is rising.

• If marginal is below average, average is falling.
• Graphing Total, Marginal, and Average Relations

• Total is the sum of marginals.

Deriving Totals from Marginal and Average Curves
Deriving Totals from Marginal and Average Curves
 Rationality

Economists make the assumption that people act rationally. This means
that consumers and producers measure and compare the costs and
benefits of a decision before going ahead.
Ex:
▪ whether eating at home is cheaper than going to a restaurant.
▪ Whether the owner of a firm also acts as the manager of the firm.
▪ Whether to train the existing workers or recruit new workers for the
newly opened unit of the firm, and so on.
 Rationality
▪ However, it may be more enjoyable to eat at the restaurant;

▪ the owner can employ a manager;

▪ training existing workers may be costlier than hiring trained workers,

and so on.
 Rationality
• Thus rationality involves making a choice that gives the greatest
benefit relative to cost. All of conventional economic theory rests on
the assumption that consumers and producers all behave rationally,
while firms aim at maximizing profits and minimizing costs,
consumers aim at maximizing utility and minimizing sacrifice.