CHAPTER 2 MARGINALIST PRINCIPLE
Marginalism is a theory that asserts individuals make decisions on the purchase and consumption of an additional unit of a good or a service based on the additional satisfaction / benefit / utility they will receive from it. In Economics for junior college (JC) pupils, we will invoke the marginalist principle to observe how individual units in a market or economy makes decisions on consumption and production.
In simple sense, any activity one carries pout, if the resultant benefit is larger than the corresponding costs of that activity, one ought to do more of it. This is an assumption, we make in A-Level Economics as well: the individual buyer or seller is a rational in decision making.
2.1 Marginalist Principle
The marginal principle refers to an increase in the level of activity if the marginal benefit (MB) > marginal cost (MC). Optimal decision making suggest that an individual will perform an activity until the point where MB = MC.
In the case of a buyer, MB refers to the additional benefit derived from consuming a good or service, whereas MC refers to the additional cost incurred for consuming that good or service.
2.2 Objectives of Economic Agents
For our A-Level Econs course, we need to understand the various objectives of the 3 main economic agents.
For consumers, the aim is to maximise satisfaction or utility. Profit maximisation, on the other hand, is the aim of producers and firms. The aim of governments is more complex; Gov aims to maximise social welfare. Mostly, it involves the microeconomic objectives of efficiency and perhaps equity. Other times, it may also involves the macro economic objectives of Economic Growth, Unemployment, Inflation, Balance of payment, Exchange rates, etc.
2.3 Rational Decision Making Process
Generally, we can assume individual consumers and producers are rational and are also motivated by self-interest. meaning, they will aim to maximize their own gains, and mostly do not care or take into account their own actions on others. Each of the economic agent will thus follow the golden rule of the Marginalist Principle. For the sake of fulfilling application skills in A-Level exams, you need to simply weighing the costs and benefits in decision-making. This marginalist approach to weighing will suffice.
For consumers, MB = MC becomes MU = MC, where
Marginal utility (MU) refers to the additional utility derived from consuming a product, whereas marginal costs (MC) refers to the additional cost incurred for consuming that product.
Intuitively, we as individuals do make rational decisions at the margin. For instance, it is now 11pm, and you just finished watching Agent of SHIELD, Season 6, Episode 6, and the episode ends with a cliff-hanger (by Marvel, of course!). You would be thinking to yourself ,”It is only 11pm. I can watch 1 more episode and then go to sleep by 12pm. Tomorrow, I still would be able to pass my NAPFA fitness test. Well, you have just performed a simple Cost- Benefit Analysis with the simple Marginal Approach: the additional satisfaction from watching Episode 7 exceeds the additional costs of watching that episode, which is the loss of energy and effort for next day’s fitness test. (Thus, MB > MC)
However, most likely, you would NOT watch episode 8, afterwards. Cos the additional satisfaction from watching Episode 8 is less than the additional costs of watching that episode, which is you may fail the fitness test, and then have to redo the test again in future. (Thus, MB < MC).
So, to be totally following the rule optimal, you may actually end up watching episode 8, 10minuites into it, and then switched off the device. Of course, we don’t have to do that to realise that, we are always intuitively following the MB = MC rule.
2.3.1 Decision Making by Firms & Government
For producers, MB = MC becomes MR = MC, where
Marginal revenue (MR) refers to the additional revenue earned from selling a good or service, whereas MC refers to the additional cost incurred for producing that good or service. A firm may incur both fixed costs and variable costs in the short run when in production. More on this marginal approach of MR= MC in the topic for Market Structures.
(Sample essays for Market Structures here)
For government, MB = MC becomes MSB = MSC, where
Marginal social benefit (MSB) refers to the additional social benefit derived from society consuming a good or service, whereas Marginal social costs (MSC) refers to the additional cost incurred by society for producing that good or service. Sometimes, there are subtle costs incurred on society, also known as marginal external costs (MEC), that are easily ignored by even the rational consumers and producers. More on this marginal approach of MR= MC in the topic for Market Failure & market efficiency.
(Sample essays for Market Failure here)
2.3.2 Limitations of Marginalist Principle
One obvious example is the difficulty to quantify and estimate the exact size of MB / MSB and MC / MSC.
A recent example: A particularly relevant example and widespread case could be a MRT (mass rapid transit) development in a housing estate in Singapore. The externalities of both positive and negative can be far reaching as a result of this development. Cost-benefit analysis (CBA) by the government, however, genuinely attempts to quantify the opportunity costs to society of the various possible outcomes as a result of this development. It seeks to include all the costs and benefits, not just private ones. But there are costs and benefits where no market is available. For example, how can the government precisely value the degradation of scenic beauty of a hill or the loss of forested area or the value of living near a MRT station? This is exactly what is happening to the Cross Island Line (CIL). Residents affected by the construction of the CIL raised that the government is not considering enough negative impacts on their well-being. In addition, the voiceless nature, especially near the areas of MacRitchie Reservoir would suffer environmental damage, and a huge loss of nature trail beauty to outdoor persons. What’s the chance of the SG government estimating correctly the MB and MC?
Thus, the ability to recognise constraints, trade-offs, as well as intended and unintended consequences when using marginalist approach / principle is crucial. Similarly, when gathering information and considering perspectives. More on this in our JC Econs lessons.
2.4 Cost Benefit Analysis (CBA)
For JC A-Level Econs, a complete CBA is not required. Thus, there is no need to perform present value analysis and discounting of benefits, costs, etc.
Here is a sample question (merely for discussion sake. Not to expect it in your H2 Econs essay exams.)
1. You have been tasked to head a team appointed by the government of S’pore to carry out a cost benefit analysis of the building of Terminal 5 at Changi Airport.
Source: Changi Airport T5
(a) Explain why infrastructure such as an airport terminal is often provided by the government. [10]
(b) Discuss how might the SG Government use the concept of cost benefit analysis (CBA) to decide whether to proceed with the T5 project. [15]
2.5 Sample Essay Exam Questions for Marginal Principle
1(a) Explain how, according to economists, the pursuit of self-interest by consumers and producers can help to address the problem of scarcity. [10]
1(b) Discuss whether the price mechanism will always allocate scarce resources efficiently for all goods and services in a market economy. [15]
2(a) Explain the factors in decision making by a rational student on whether to participate in university education, and by a seller on whether to produce non-salted potato chips. [10]
2(b) Discuss whether the government in Singapore is satisfied with the rational decision making of students regarding university education. [15]
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