1.6 Marginal Analysis and Consumer Choice

a. Define the key assumptions of consumer choice theory. b. Explain (using a table or graph as appropriate) how a rational consumer’s decision making involves the use of marginal benefits and marginal costs. c. Calculate (using a table or a graph when appropriate) how a rational consumer’s decision making involves the use of marginal benefits and marginal costs.

• Consumers face constraints and have to make optimal decisions accounting for these constraints.
• In a model of rational consumer choice, consumers are assumed to make choices so as to maximize their total utility.
• Consumers experience diminishing marginal utility in the consumption of goods and services.
• Consumers allocate their limited income to purchase the combination of goods that maximizes their utility by equating/comparing the marginal utility of the last dollar spent on each good. Exclusion: Indifference curves are beyond the scope of the course and the AP Exam, but equating the ratios of marginal utility to price is within the scope.
• Enduring understanding CBA-2: To determine the optimal level at which to pursue an activity whose total benefits exceed total cost, rational economic agents compare marginal benefits and marginal costs.

a. Define marginal analysis and related terms. b. Explain a decision using marginal analysis (using a table or a graph when appropriate).

• Marginal analysis involves comparing the additional benefit of increasing a given activity with the additional cost. Comparing marginal benefit (MB) with marginal cost (MC) helps individuals (firms) decide whether to increase, decrease, or maintain their consumption (production) levels.
• The optimal quantity at any point in time does not depend on fixed costs (sunk costs) or fixed benefits that have already been determined by past choices.
• The optimal quantity is achieved when marginal benefit is equal to marginal cost or where total benefit is maximized.
• Enduring understanding CBA-2: To determine the optimal level at which to pursue an activity whose total benefits exceed total cost, rational economic agents compare marginal benefits and marginal costs.