Cost-Benefit Analysis

🪴Learn: Marginal Benefit as Demand

You may still be confused at why we use Marginal Benefit and Cost rather than Total Benefit and Cost in our decision making.

Here's a quick example: a cellphone has a marginal cost of $1,000 each (at least it used to). You need a cellphone for your work and communication which you value to be a benefit of $3,000. This means your marginal benefit from 0 to 1 phones is $3,000. Do you buy three phones?

No. This is because your marginal benefit from the second phone (MB from 1 to 2 phones) is much lower than $1,000, let alone buying the third one.

🤔Reflect: Perspectives of Cost-Benefit Analysis

Taking on different perspectives, we can come to different conclusions. We assume that the perspective that we take is rational and self-interested

Perspective of the Firm
Perspective of the Consumer
Perspective of a Social Planner (Government)

Social = Private + Externalities

MSB = MPByourself + MPBothers + other external benefits

MSC = MPCyourself + MPCothers + other external costs

Other people are externalities when thinking from the perspective of yourself

🪴Learn: Firm Social Cost & Policy

🪴Learn: Full Cost-Benefit Analysis Example

💪Practice: Cities Cleaning Lake

Toronto and Hamilton are thinking about installing a number of water cleaning filters in the lake. Each water filter costs $90 each. Their total benefit (in $ saved from healthcare) from water cleaners is in the table below:

(a) Fill in the Marginal Benefit columns for Toronto and Hamilton

(b) How many water filters would Toronto purchase alone? (private decision-making)

As decision makers, we would choose to the decision option if and only if...

benefit of the decision ≥ cost of the decision

Toronto will purchase 1 water filter.
Hamilton will purchase 0 water filters.

The total number of water filters with private decision-making is 1 water filter.

(c) How many water filters would both cities purchase if they worked together?

As decision makers, we would choose to the decision option if and only if...

benefit of the decision ≥ cost of the decision

Together, they will purchase 2 water filters because the marginal benefit exceeds marginal cost when purchasing up to two water filters.

The total number of water filters with private decision-making is 2 water filter.

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