Copyright Goodheart-Willcox Co., Inc. 16 Chapter 1 Financial Literacy Basics money. Cost-benefit analysis makes these decisions more rational and well- reasoned. This principle applies to economic decisions of individual consumers, businesses, and governments. It is a strategy to use to make decisions to satisfy needs and wants. Is the benefit worth the cost? Marginal Analysis Marginal analysis is also a powerful decision-making tool, particularly in business. It measures the added benefit, versus the added cost, of one more unit of a product. The change in total benefit of using one additional unit is the marginal benefit. The change in total cost of using one more unit is the marginal cost. For example, suppose you are hungry and buy an apple. It tastes so good that you buy another and another. Will the second apple bring as much satisfaction as the first one? Probably not, because you are less hungry. The third apple will be even less satisfying. You would probably be willing to pay more for that first apple than for the second, more for the second than for the third. Eventually, you stop eating because you get little or no benefit since your stomach is full. The economic law of diminishing marginal utility states that the marginal benefit of using each additional unit of something tends to decrease as the quantity used increases. The law applies to thrill rides, snacks, movie tickets, and many other experiences and purchases. It is particularly useful in business when measuring the cost of increasing production. By using marginal analysis, businesses can determine the right number of workers needed to maximize their profits. This principle also applies to economic decisions of individual consumers, Economics in Action Marginal Analysis Marginal analysis can help businesses use resources in the best way possible. For example, suppose five workers in a toy factory produce 100 large, stuffed teddy bears per day. Each worker makes 20 teddy bears. They sew the toy’s arms, legs, torso, and head separately. Then they stuff the parts and sew them together. The sewing room has five heavy-duty machines. The manager hires two more workers, but does not buy new machinery. She reasons that time used to stuff the pieces can be done away from the sewing machines. This should leave some machines free for the new workers to sew more teddy bears. The seven workers handle the new work arrangement well and produce 20 teddy bears each, or 140 per day. This success inspires the manager to add one more worker, but she does not get the results she expects. The number of teddy bears produced is only 152, not the 160 she expected. Workers average only 19 teddy bears apiece. They must stand in line to use equipment, which slows them down. The manager realizes that increasing the total production by only 12 teddy bears daily does not cover the cost of the eighth worker.