1.2.3. Marginal Analysis & Sunk Cost

A second key concept used in analyzing choices is the notion of marginalism. In weighing the costs and benefits of a decision, it is important to weigh only the costs and benefits that is derived directly from, or contingent of the decision. See the example below.

Example of Marginal Cost

Suppose you live in London and that you were weighing the cost and benefits of visiting a friend in the City of Atlanta. Very luckily you won a free ticket of the Great Atlantic Liner setting out from London to Miami, Florida, and of course you decided to take the journey. In this situation, the cost of visiting your friend in Atlanta would be only the additional, or marginal, time and money spent in order to get Atlanta from Miami.

Economic choices are largely based on a comparison between the expected marginal cost and the expected marginal benefit of the action under consideration. Marginal means incremental, additional, or extra. Rational decision makers will make the choice as long as the expected marginal benefit from the change incurred by the choice exceeds the expected marginal cost. To acquire an intuitive vision of marginalism, refer to the illustration below.

Decreasing Marginal Benefit

You can see a decreasing marginal benefit against a constant marginal cost, because every additional bottle of Coca Cola is bought at the same price. When you are scorchingly thirsty, a bottle of iced Coca Cola can give you so much satisfaction and enjoyment that you value it far above its price and you buy it without any hesitation. However, as you drink more, you are not that thirsty any more and value the same bottle of iced Coca Cola not so much as you previously did. Your thirsty is reduced little by little with every additional unit of Coca Cola until you eventually value a bottle of Coca Cola equally with its price. And your incentive to buy it finally disappears. .

In marginal analysis, one of the concepts that cannot be missed out is sunk cost. Sunk costs are costs that cannot be avoided for any nonzero units of products and that do not change regardless of the quantity of production. As opposed to sunk cost, marginal cost is the cost that is relevant to the quantity produced and that do not occur with a zero production. To simplify, marginal cost is the very cost incurred by one additional unit of production.

Example of Sunk Cost

Consider the cost of producing a book, say Michael Parkin's Macroeconomics. Assume that 15,000copies are produced. The total cost of producing the copies includes the cost of the authors' time in writing the book, the cost of editing, the cost of making the plates for printing, the cost of the paper and ink, and perhaps the cost of advertising. If the total cost amounts up to $900,000, then the average cost of one copy would be $60.

Suppose a second printing is brought onto agenda. Should another 10,000 copies be produced? In deciding whether to proceed, the costs of writing, editing, making plates, and so forth are irrelevant in that they have already been incurred in the previous 15,000 copies. That is, they are sunk costs.