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BALANCING BENEFITS
AND COSTS
3
Read More
L EARNING O BJECTIVES Online, Calculus
Worked-Out
Problems, and
Calculus In-Text
After reading this chapter, students should be able to: Exercises
available at
} Understand the concept of maximizing benefits less costs. www.mhhe.com/
bernheim2e, or
scan here. Need a barcode reader? Try
} Describe what it means to think on the margin. ScanLife, available in your app store.

} Explain the concepts of marginal benefit and marginal cost.

} Use marginal analysis to identify best choices.
} Understand why sunk costs can be ignored in making economic decisions.

L
ast week your 2002 Honda Civic broke down for the second time in a month,
jeopardizing your after-school pizza delivery job. You and your “Civ” have been
through some good times together, but you’ve reluctantly concluded that it’s
time to replace it with another car. Before you sell it, however, you may want to
spend some money to fix it up.
Think about the benefits of having a mechanic work on your car: The more
problems you fix, the more money you’ll get for it. Indeed, some things that don’t
cost that much to fix can greatly increase its resale value. But fixing your car also has
costs. Your mechanic’s time isn’t cheap, nor are the parts she uses. And while the car
is in the repair shop, you won’t be able to do your delivery job. Making the right deci-
sion involves balancing these benefits and costs.
Many decisions we’ll study in this book involve such trade-offs. In this chapter,
we will see how economists think about such problems and learn tools that we’ll use
over and over again throughout the book. The chapter can be studied at the start
of a course, or used as a reference while reading later chapters. It covers four topics:
1. Maximizing benefits less costs. We’ll discuss how making good economic decisions
involves consideration of each possible choice’s benefits and costs.
2. Thinking on the margin. Economists often think about a choice in terms of its
marginal benefits and marginal costs. We’ll define these concepts and examine
their relationships to best choices.
57

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58 Part I Introduction

3. Sunk costs and decision making. In some situations, a decision is associated with
costs that the decision maker has already incurred or to which she has previously
committed. Economists call such expenses sunk costs. We’ll see that decision
makers should ignore sunk costs when choosing their actions.
*4. Constrained optimization. Often a decision maker faces a constraint that affects
several decisions, requiring that she make trade-offs among them. We’ll discuss
how to solve such problems.

3.1 MAXIMIZING BENEFITS LESS COSTS

Let’s take a closer look at your car repair decision. Consider first the benefits of
repairing your car. Table 3.1 shows how the price you’ll get for your car depends on
the number of hours your mechanic works on it. Notice that the more repair time,
the more your car is worth. For example, your car will be worth $1,150 more if your
mechanic works on it for two hours, and $1,975 more if she works on it for four hours.
Now let’s think about the costs. First, you’ll have to pay for your mechanic’s time
and the parts she uses. For example, Table 3.2 shows that the cost of two hours of
your mechanic’s time and parts is $350. Second, you won’t be able to work at your
pizza delivery job while your car is being repaired. For example, Table 3.2 shows that
those two hours of repair work will cost you $30 in lost wages. Your total cost (also
shown in Table 3.2) is the sum of these two costs.
Notice that the costs of repairing your car are of two different types. When you
hire your mechanic and buy parts, you incur an out-of-pocket cost. But when repair-
ing your car forces you to skip your pizza delivery job, no money comes out of your
An opportunity cost is
the cost associated with pocket; instead, you forgo the opportunity to have others hand money to you. That
forgoing the opportunity to type of cost is known as an opportunity cost—the cost associated with forgoing the
employ a resource in its best opportunity to employ a resource in its best alternative use.1 Here, you forgo the
alternative use.
opportunity to use your car to deliver pizzas.

Table 3.1 Table 3.2

Benefits of Repairing Your Car Costs of Repairing Your Car

Repair Time Repair Time Cost of Mechanic Lost Earnings

(Hours) Total Benefit (Hours) and Parts from Pizza Delivery Job Total Cost

0 $0 0 $0 $0 $0
1 615 1 135 15 150
2 1,150 2 350 30 380
3 1,600 3 645 45 690
4 1,975 4 1,020 60 1,080
5 2,270 5 1,475 75 1,550
6 2,485 6 2,010 90 2,100

1As a general matter, the cost you incur in paying your mechanic could also be viewed as an opportunity cost since when you
hand over your money you forgo the opportunity to spend that money on something else. However, we will typically reserve the
term opportunity cost for implicit or hidden costs such as your lost pizza delivery income, and not direct out-of-pocket expenses.

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Chapter 3 Balancing Benefits and Costs 59

Table 3.3
Total Benefit and Total Cost of Repairing Your Car

Repair Time
(Hours) Total Benefit Total Cost Net Benefit

0 $0 $0 $0
1 615 150 465
2 1,150 380 770
Best choice 3 1,600 690 910
4 1,975 1,080 895
5 2,270 1,550 720
6 2,485 2,100 385

To make the right decision, you need to find the number of repair hours that
maximizes your net benefit—the total benefit you derive less the total cost you incur. Net benefit equals total
Table 3.3 shows the total benefit, total cost, and net benefit for each of your possible benefit less total cost.
choices. The best choice is three hours, which has a net benefit of $910.
Figure 3.1 graphs the total benefits and total costs from Table 3.3. The horizon-
tal axis measures the number of repair hours and the vertical axis measures total
benefit and total cost. The figure shows the total benefit for each number of hours
in blue and the total cost in red. At the best choice of three hours, the vertical dis-
tance between the blue total benefit point and red total cost point is larger than at
any other number of hours. Want the video or
text solution? Visit
Application 3.1 discusses an important personal decision for which benefits and www.mhhe.com/
costs can be compared: the decision to attend college. bernheim2e or
scan here. Need a
barcode reader? Try
IN-TEXT EXERCISE 3.1 Suppose your mechanic lowers the amount she charges by ScanLife, available in
your app store.
$25 an hour. The total benefits are the same as in Table 3.1. What is your best choice?

Figure 3.1
2,400 Total Benefit and Total Cost
of Repairing Your Car. This
2,000 figure shows the total benefits
Total benefit, total cost ($)

from Table 3.3 in blue and the

total costs in red. The best choice
1,600
is three hours, which results in
a net benefit of $910. That is
1,200 910 the number of hours at which
the vertical distance between the
800 blue and red dots is greatest.

400 Best choice

1 2 3 4 5 6
Repair hours

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60 Part I Introduction

Application 3.1

Benefits and Costs of a College Degree

W hat do Bill Gates and LeBron James have in common,

aside from being very, very rich? The answer is that
neither earned a college degree.
Each year millions of high school students decide to go to
college. Is a college degree a good investment for the typical
student? The answer involves a comparison of the benefits and
costs. While a college education has many benefits (for example,
you will become a much more interesting dinner companion),
we’ll look only at its effects on lifetime earnings.
Table 3.4 shows the average earnings of high school and
college graduates in the years 2000–2009.2 Clearly college
graduates earn quite a bit more than high school graduates. Over
a lifetime, the extra earnings are worth about $670,000 before What do Bill Gates and LeBron James have in common?
taxes and about $470,000 after taxes.3
But what about the costs of attending college? One obvious
the University of Texas at Austin cost a Texas resident about $9,000,
cost is tuition, which varies tremendously. Public (state) colleges
while a year at a private college can cost over $40,000. Overall,
cost much less than private schools. For example, in 2011, a year at
over 65 percent of four-year-college students attended colleges
where tuition was less than $15,000. In addition, many students
paid reduced tuition through their college’s financial aid programs.
Table 3.4 On top of tuition, books cost them roughly $1,000 per year.
Average Annual Earnings of High School But tuition and books are not the only costs of going to
and College Graduates, 2000–2009 college. There’s also an important opportunity cost: while you’re
in college you probably can’t hold a full-time job. According to
Age High School Graduates College Graduates
Table 3.4, for an average high school graduate of age 25 to 29,
25–29 $30,029 $46,051 this cost is roughly $30,000 per year, which comes to about
30–34 33,388 59,812 $21,000 per year after taxes—exceeding tuition costs for most
35–39 36,740 71,633 students. (For college students younger than 25, the lost earnings
40–44 38,909 77,617 are probably a little less than this.) On an after-tax basis, this
45–49 40,419 80,070 opportunity cost raises the cost of a college education for those
50–54 40,754 78,106 paying full tuition to roughly $150,000, or $250,000 for the most
55–59 39,858 73,633 expensive private colleges.
60–64 38,872 70,928 With a total benefit of over $450,000 and a total cost below
$250,000, going to college looks like a good decision!4

2These figures come from work reported on in Anthony P. Carnevale, Stephen J. Rose, and Ban Cheah, “The College Payoff: Education, Occupations, Lifetime Earn-
ings,” Georgetown University Center on Education and the Workforce.
3In Chapter 10 we explain how to calculate the value of an income stream that is spread out over time.
4These estimates of the effect of a college degree on lifetime earnings have two shortcomings. First, the average income in Table 3.4 for a college graduate is the
average for those individuals who have only a college degree, not a more advanced degree. As such, it overlooks the fact that getting a college degree gives you the
option to get a more advanced degree that could further increase your lifetime earnings—and therefore it understates the true effect of a college degree on your
lifetime earnings. On the other hand, it may also overstate the true increase in earnings that comes with a college degree. If smart people tend to get more education,
and employers like to hire smart employees, part of the extra salary that college graduates earn may be due to their intelligence rather than to the extra time they
spent in the classroom.

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Chapter 3 Balancing Benefits and Costs 61

What about Bill Gates and LeBron James? In some cases, most profitable software company. When LeBron James decided
the opportunity costs of going to college are so great that getting to skip college and go directly to the NBA, he signed a three-year
a degree doesn’t make sense, at least not from the perspective $12.96 million contract with the Cleveland Cavaliers, along with
of maximizing lifetime earnings. In 1975, Bill Gates dropped out a highly lucrative endorsement deal with Nike. For both Bill Gates
of Harvard to start Microsoft. Had he stayed in school, he would and LeBron James, the opportunity costs of a college degree
probably have missed the opportunity to found the world’s largest, were just too high relative to the benefits.5

Maximizing Net Benefits with Finely Divisible Actions

Many quantities, such as time, can be divided into very tiny units (such as minutes,
seconds, etc.). When this is so, it is often a convenient approximation to treat that
quantity as if it is “finely divisible,” so that the decision maker can adjust his choice
in arbitrarily small increments.
As an illustration, consider again your car repair decision. If repair time is
finely divisible, we can use total benefit and total cost curves to find the best choice.
Figures 3.2(a) and (b) show the total benefit and total cost curves, respectively, for
your car repair decision. The horizontal axes measure hours of your mechanic’s
time. The vertical axes measure in dollars either the total benefit [in panel (a)]
or the total cost [in panel (b)] of the various possible amounts of repair work.
To draw these figures, we assume that the total benefit with H hours of repair work
is described by the function B(H ) 5 654H 2 40H 2 and the total cost is described
by the function C(H ) 5 110H 1 40H 2. (The total benefits and costs in Table 3.3

Figure 3.2
Total Benefit and Total Cost Curves When Repair Time Is Finely Divisible. The blue curve in (a) shows the total benefit from repairing your car for
each amount of repair work between zero and six hours. It represents the total benefit function B(H ) 5 654H 2 40H 2. The red curve in (b) shows the total
cost of repairing your car for each amount of repair work between zero and six hours. It represents the total cost function C(H ) 5 110H 1 40H 2. The two
curves are combined in (c), which shows that the net benefit (which equals the vertical distance between the two curves at any given number of hours) is
largest at a choice of 3.4 hours. In this case, total benefit is $1,761.20, total cost is $836.40, and net benefit is $924.80.

(a) Total benefit (b) Total cost (c) Total benefit versus total cost

B B
Total benefit, total cost ($)

2,270
Total benefit ($)

C C
Total cost ($)

1,761.20 924.80
1,602 1,550

836.40
614 690

150
0 1 2 3 4 5 6 0 1 2 3 4 5 6 0 1 2 3 4 5 6
Hours (H ) Hours (H ) 3.4
Hours (H )

5Gates’s future earnings from his decision to drop out of college were, however, uncertain. In Chapter 11, we’ll discuss how to evaluate uncertain returns.

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62 Part I Introduction

Figure 3.3
Net Benefit When Repair Time
Is Finely Divisible. This figure
shows the difference between the 924.80
total benefit and total cost curves
in Figure 3.2, which equals the B–C
Net benefit ($)
net benefit. The curve is highest
at 3.4 hours, where total benefit
exceeds total cost by $924.80.

0
0 1 2 3 4 5 6
3.4
Hours (H)

correspond to the values of these functions, rounded to the nearest $5.) Both the
total benefit and total cost increase as the amount of repair work rises from zero
to six hours.
Figure 3.2(c) combines these two curves and identifies the best choice, which
gives you the largest possible net benefit (total benefit less total cost). Graphically, it
is the number of hours at which the vertical distance between the total benefit and
total cost curves is largest. In Figure 3.2(c), your best choice is 3.4 hours, at which
point total benefit is $1,761.20 and total cost is $836.40. The difference between total
benefit and total cost at 3.4 hours is $924.80.6
Figure 3.3 shows the net benefit, B 2 C, in the form of a curve (the horizontal
axis again measures the number of repair hours, while the vertical axis now measures
the net benefit, the difference between the total benefit and total cost). The best
choice of 3.4 hours leads to the highest point on the curve.7

3.2 THINKING ON THE MARGIN

Another way to approach the maximization of net benefits involves thinking in terms
of marginal effects. When economists think about a decision, they focus on its mar-
ginal benefits and marginal costs. These concepts capture the way total benefit and
cost change as the activity changes a little bit. Consider again your car repair decision.
Marginal benefit and marginal cost measure how much your benefits and costs change
due to a small change in repair time—the smallest change that is possible. Letting
H denote the total repair time you choose, we’ll call the size of this smallest change
DH. (The Greek symbol D, called delta, refers to a change in a variable.) In Table 3.1,

6This net benefit is larger than the largest net benefit in Table 3.3 and Figure 3.1, where repair hours could only be chosen in
increments of an hour. Having more flexibility (the ability to hire your mechanic in finer increments) allows you to do better.
7For a practical illustration of a decision with a finely divisible action, look at Read More Online 3.1, which explains how the
Environmental Protection Agency compared benefits and costs to decide upon the allowable level of arsenic in drinking water.

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Chapter 3 Balancing Benefits and Costs 63

DH 5 1, since your mechanic charged for her time in one-hour increments. If instead
she were to charge in half-hour increments, then DH would equal 0.5. When you are
purchasing H hours of repair time, the last DH hours you purchase are called the mar-
ginal units of repair time. More generally, for any action choice X, the marginal units The marginal units of action
are the last DX units, where DX is the smallest amount you can add or subtract. choice X are the last DX units,
where DX is the smallest
Marginal Cost amount you can add or
subtract.
Marginal cost (MC ) measures the additional cost you incur because of the last DH
hours of repair time (the marginal units of repair time). Specifically, suppose that
C(H ) is the total cost of H hours of repair work. [For example, in Table 3.2, the total
cost of three hours of repair work is C(3) 5 $690.] When you pay for H hours of
repair work, the extra cost due to the last DH hours is DC 5 C(H ) 2 C(H 2 DH ),
which is the cost of H hours of repair time less the cost of H 2 DH hours.
This is simple enough. The only added complication is that economists measure
marginal cost on a per unit basis. That is, we divide the extra cost by the number of
marginal hours, DH:
DC C(H) 2 C(H 2 DH)
MC 5 5 (1)
DH DH
This expression tells us how much marginal repair time costs per hour. More gener-
ally, the marginal cost of an action at an activity level of X units equals the extra cost The marginal cost of an
incurred due to the marginal units, C(X) 2 C(X 2 DX), divided by the number of action at an activity level of
X units equals the extra cost
marginal units, DX. That is, MC 5 [C(X) 2 C(X 2 DX)]/DX. incurred due to the marginal
If measuring the change in cost on a per-unit basis seems confusing, consider a units, C(X ) 2 C(X 2 D X ),
familiar example. Imagine that you’re in the supermarket, trying to decide between a divided by the number of
marginal units, D X.
one-pound jar of peanut butter that costs $1 and a one-and-one-half-pound jar that
costs $1.25. Is the larger jar a good deal? That depends on how much the extra peanut
butter costs per pound. If you choose the larger jar, you get an extra one-half pound
of peanut butter for an extra $0.25. So the extra peanut butter costs only $0.50 per
pound ($0.25 divided by one-half pound)—half the price of the first pound. When
we calculate the marginal cost of repair time using formula (1), we’re doing the same
thing: we measure the additional cost of the marginal units on a per-unit basis.
Table 3.5 shows how the total cost and marginal cost of repair work depend
on the number of hours. Since you can vary repair work in one-hour increments
(DH 5 1), formula (1) in this case simplifies to MC 5 C(H) 2 C(H 2 1). So the
entries in the marginal cost column are just the change in cost due to the last hour
of time purchased (represented graphically by the dashed arrows). For exam-
ple, your marginal cost when you choose three hours of repair work (H 5 3) is
C(3) 2 C(2) 5 690 2 380 5 $310 per hour.

Marginal Benefit
We can find the marginal benefit (MB) of repair work in a similar way. Suppose that B(H )
is the total benefit of H hours of repair work. Then when you choose H hours of repair
work, the extra benefit from the last DH hours is DB 5 B(H ) 2 B(H 2 DH ). Dividing by
DH expresses this change on a per-hour basis, which gives the marginal benefit:
DB B(H) 2 B(H 2 DH)
MB 5 5 (2)
DH DH

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64 Part I Introduction

Table 3.5 Table 3.6

Total Cost and Marginal Cost Total Benefit and Marginal Benefit
of Repairing Your Car of Repairing Your Car

Repair Time Marginal Cost Repair Time Total Marginal Benefit

(Hours) Total Cost ($) (MC) ($/hour) (Hours) Benefit ($) (MB) ($/hour)

0 $0 — 0 $0 —
1 150 $150 1 615 $615
2 380 230 2 1,150 535
3 690 310 3 1,600 450
4 1,080 390 4 1,975 375
5 1,550 470 5 2,270 295
6 2,100 550 6 2,485 215

The marginal benefit of an

More generally, the marginal benefit of an action at an activity level of X units equals
action at an activity level of X the extra benefit produced by the DX marginal units, measured on a per-unit basis.
units equals the extra benefit That is, MB 5 DB/DX 5 [B(X) 2 B(X 2 DX)]/DX.
produced by the marginal
units, B(X) 2 B(X 2 DX),
Table 3.6 shows the total and marginal benefits for your car repair decision. The mar-
divided by the number of ginal benefit corresponds to formula (2) where DH 5 1, so MB 5 B(H ) 2 B(H 2 1).
marginal units, DX.
IN-TEXT EXERCISE 3.2 Suppose you can hire your mechanic in quarter-hour
Want the video or
increments. For repair work up to two hours, the total benefit (in dollars) is
text solution? Visit B(0) 5 0, B(0.25) 5 30, B(0.5) 5 60, B(0.75) 5 90, B(1) 5 120, B(1.25) 5 140,
www.mhhe.com/
bernheim2e or
B(1.5) 5 160, B(1.75) 5 180, B(2) 5 200. What is the marginal benefit of repair
scan here. Need a time (measured on a per-hour basis) at each of these possible choices?
barcode reader? Try
ScanLife, available in
your app store.
Best Choices and Marginal Analysis
By comparing marginal benefits and marginal costs, we can determine whether
an increase or a decrease in the level of an activity raises or lowers the net benefit.
For an illustration, look at Table 3.7, which lists together the marginal benefits and

Table 3.7
Marginal Benefit and Marginal Cost
of Repairing Your Car

Repair Time Marginal Benefit Marginal Cost

(Hours) (MB) ($/hour) (MC) ($/hour)

0 — —
1 $615 . $150
2 535 . 230
Best choice 3 450 . 310
4 375 , 390
5 295 , 470
6 215 , 550

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Chapter 3 Balancing Benefits and Costs 65

marginal costs shown in Tables 3.5 and 3.6. Is one hour of repair work better than
zero? According to the table, the marginal benefit of the first hour is $615, while the
marginal cost is $150. Since 615 is larger than 150 (as indicated by the “.” sign in the
table), one hour of repair work is better than none—you come out ahead by $465 (that
is, $615 2 $150). Next, suppose you’re thinking about hiring your mechanic for five
hours. Is the last hour worthwhile? According to the table, the marginal benefit of the
fifth hour is $295, which is less than the marginal cost ($470). So it’s better to hire your
mechanic for four hours than for five—you lose $175 ($470 2 $295) on the fifth hour.
If you are making a best choice, then by definition neither a small increase nor
a small decrease in your choice can increase your net benefit. Thus, at a best choice,
the marginal benefit of the last unit must be at least as large as its marginal cost, and
the marginal benefit of the next unit must be no greater than its marginal cost. That
is, if X* is a best choice, then MB $ MC at X*, and MB # MC at X* + DX. We call
this the No Marginal Improvement Principle.

The No Marginal Improvement Principle At a best choice, the marginal benefit of the
last unit must be at least as large as its marginal cost, and the marginal benefit of the next
unit must be no greater than its marginal cost.

For an illustration, look again at Table 3.7. As you saw in Table 3.3, the best
choice is three hours. Notice that the marginal benefit of the third hour exceeds the
marginal cost ($450 versus $310), and the marginal benefit of the fourth hour is less
than the marginal cost ($375 versus $390), just as the No Marginal Improvement
Principle says they must be.

Marginal Benefit and Marginal Cost

with Finely Divisible Actions
Now let’s see how to define MB and MC when actions are finely divisible. Figure 3.4
shows again the total benefit curve from Figure 3.2(a). Suppose we choose any

Figure 3.4
Slope 5 MB Using the Total Benefit
Curve to Find the Marginal
Benefit. When actions are finely
A divisible, the marginal benefit at
B(H)
H hours of repair time equals the
Total benefit ($)

slope of the total benefit curve at

H hours, here labeled as point A.
This slope equals the slope of the
solid black line drawn tangent to
the curve at that point.

H
Hours (H )

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66 Part I Introduction

point on the curve, such as the point A associated with H hours (see the figure).
The marginal benefit associated with H hours of repair time equals the slope of the
total benefit curve at point A. This slope is shown by the black line drawn tangent
to the total benefit curve at that point (the tangent line at point A touches but does
not cross the curve at that point). The slope of that line measures DB/DH (“rise over
run”) for very small changes in hours starting at H hours. (To read more about why
the slope of this tangent line equals the marginal benefit, see Read More Online 3.2.)
This relationship between MB and the slope of the total benefit curve is sum-
marized as follows:

The Relationship between Marginal Benefit and the Total Benefit Curve
When actions are finely divisible, the marginal benefit when choosing action X equals
the slope of the total benefit curve at X.
Marginal benefit and
marginal cost at H hours
are the derivatives of
the total benefit and total cost The exact same principle governs the relationship between marginal cost and the
functions at H hours. That is,
MB 5 B9(H ) and MC 5 C9(H ).
total cost curve:
To see why, look at Read More
Online 3.3.
The Relationship between Marginal Cost and the Total Cost Curve
When actions are finely divisible, the marginal cost when choosing action X equals the
slope of the total cost curve at X.

Marginal Benefit and Marginal Cost Curves By computing the mar-

ginal benefit at many different levels of H, we can graph the marginal benefit
curve. Figure 3.5(b) shows the marginal benefit curve for the total benefit curve in
Figure 3.2(a), which is reproduced in Figure 3.5(a). In Figure 3.5(a), we’ve drawn
straight lines tangent to the total benefit curve at three different numbers of hours:
H 5 1, H 5 3, and H 5 5. The slope of each line equals the marginal benefit at each
of those levels. Figure 3.5(b) plots the marginal benefit at those levels and others.
Note that the marginal benefit curve slopes downward. In other words, marginal
benefit shrinks as the amount of repair work increases. This reflects the fact that the
tangent lines in Figure 3.5(a) become flatter as we move from left to right along the
total benefit curve.
The same idea applies for graphing the marginal cost curve. Figure 3.6(a) repro-
duces the total cost curve from Figure 3.2(b), with the addition of tangent lines at
H 5 1, H 5 3, and H 5 5. Figure 3.6(b) shows the marginal cost at those levels
and others. Note that the marginal cost curve slopes upward. In other words, mar-
ginal cost grows larger as the amount of repair work increases, reflecting the fact
that the tangent lines in Figure 3.6(a) become steeper as we move from left to right
along the total cost curve.
We can describe the particular marginal benefit and cost curves shown in
Figures 3.5(b) and 3.6(b) by the functions MB(H ) 5 654 2 80H and MC(H ) 5 110 1
80H, respectively. How do we know this? Economists usually find formulas for mar-
ginal benefits and marginal costs using calculus. (As we noted in the calculus margin
note above, the marginal benefit is the derivative of the total benefit function,

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Chapter 3 Balancing Benefits and Costs 67

and the marginal cost is the derivative of the total cost function.) Except in
specifically-designated calculus exercises, in this book we do not assume that you
know calculus, so whenever you need a marginal benefit or marginal cost function,
we will tell you what it is.

Figure 3.5
The Total and Marginal Benefit Curves When Repair Time Is Finely Divisible. Figure (a) reproduces the total benefit curve in Figure 3.2(a), add-
ing tangents to the total benefit curve at three different numbers of hours (H 5 1, H 5 3, H 5 5). The slope of each tangent equals the marginal benefit
at each number of hours. Figure (b) shows the marginal benefit curve: note how the marginal benefit decreases with the number of hours. This marginal
benefit curve is described by the function MB(H ) 5 654 2 80H.

(a) Total benefit (b) Marginal benefit

Slope 5 MB 5 254

Slope 5 MB 5 414
654
2,270 B Marginal benefit ($/hour)
Slope 5 MB 5 574 574
Total benefit ($)

1,602 414

254 MB
614

0 1 2 3 4 5 6 0 1 2 3 4 5 6
Hours (H ) Hours (H )

Figure 3.6
The Total and Marginal Cost Curves When Repair Time Is Finely Divisible. Figure (a) reproduces the total cost curve in Figure 3.2(b), adding
tangents to the total cost curve at three different numbers of hours (H 5 1, H 5 3, H 5 5). The slope of each tangent equals the marginal cost at each
number of hours. Figure (b) shows the marginal cost curve: note how the marginal cost increases with the number of hours. This marginal cost curve is
described by the function MC(H ) 5 110 1 80H.

(a) Total cost (b) Marginal cost

Slope 5 MC 5 510 C
MC
Marginal cost ($/hour)

1,550 510
Slope 5 MC 5 350
Total cost ($)

350
Slope 5 MC 5 190
690
190
110
150

0 1 2 3 4 5 6 0 1 2 3 4 5 6
Hours (H ) Hours (H )

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68 Part I Introduction

Best Choices and Marginal Analysis with Finely Divisible Actions

When actions are finely divisible we have an even simpler version of the No Marginal
Improvement Principle:

The No Marginal The No Marginal Improvement Principle (for Finely Divisible Actions) If actions
Improvement Principle
for Finely Divisible are finely divisible, then marginal benefit equals marginal cost (MB 5 MC ) at any
Actions is simply the first-order best choice, provided that it is possible to both increase and decrease the level of the
condition for a maximum,
activity a little bit.
which says that if H maximizes
B(H) 2 C(H), then B9(H ) 2
C9(H ) 5 0, or equivalently
B9(H ) 5 C9(H ). To see why MB 5 MC, suppose that action X * is the best choice. If MB were
greater than MC at X *, then a small increase in the activity level would increase
the net benefit. Likewise, if MB were less than MC at X *, then a small decrease in
the activity level would increase the net benefit. In either case, action X * would not
have been a best choice. Putting these two facts together, if it is possible to both
increase and decrease the activity level from some best choice X *, we must have
MB 5 MC at X *.
To illustrate, consider again your car repair problem. Recall that the best choice,
as shown in Figure 3.2(c), is to hire your mechanic for 3.4 hours. Figure 3.7 com-
bines the marginal benefit and marginal cost curves from Figures 3.5(b) and 3.6(b).
Note that marginal benefit equals marginal cost (visually, the two curves intersect) at
H 5 3.4. When H is less than 3.4, marginal benefit is greater than marginal cost, so
an increase in H makes you better off (as indicated by the rightward pointing arrows
on the horizontal axis). When H is greater than 3.4, marginal benefit is less than
marginal cost, so a decrease in H makes you better off (as indicated by the leftward
pointing arrows on the horizontal axis).
Figure 3.8 (like Figure 3.2) shows the total benefit and total cost curves for this
decision. Since marginal benefit and marginal cost are equal at the best choice of
H 5 3.4, the slopes of the total benefit and total cost curves at that point must be

Figure 3.7 654

Marginal Benefit Equals
Marginal benefit, marginal cost ($/hour)

Marginal Cost at a Best MC

Choice. At the best choice
of 3.4 hours, the No Marginal
Improvement Principle holds, so
MB 5 MC. At any number of 382
hours below 3.4, marginal benefit
exceeds marginal cost, so that
a small increase in repair time MB
will improve the net benefit (as
indicated by the rightward pointing
arrows on the horizontal axis). At
110
any number of hours above 3.4,
marginal cost exceeds marginal
benefit, so that a small decrease in
repair time will improve net benefit 0 1 2 3 4 5 6
(as indicated by the leftward point- 3.4
ing arrows on the horizontal axis.)
Hours (H )

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Chapter 3 Balancing Benefits and Costs 69

Figure 3.8
B
Tangents to the Total Benefit
and Total Cost Curves at the
Best Choice. At the best choice
of H 5 3.4, the tangents to the
Total benefit, total cost ($)

C
total benefit and cost curves have
the same slope and are therefore
924.80 parallel. Thus, marginal benefit
equals marginal cost.

0 1 2 3 4 5 6
3.4
Hours (H)

equal. That is, the tangent lines to the two curves at 3.4 hours must be parallel, as
shown in the figure. If that were not the case, then by varying the number of hours
in one direction or the other we could increase the distance between the total benefit
and total cost curves—and thus the net benefit.
The No Marginal Improvement Principle has numerous important applications
in microeconomics. Application 3.2 provides an illustration. You’ll see many others
throughout this book.
One of the most useful applications of the No Marginal Improvement Principle
is to the problem of finding a best choice. When there are just a few possible choices,
finding a best choice is simple. We can just compare total benefits and costs directly,

Application 3.2

The Value of a Highway Construction Project

E very day millions of Americans find themselves stuck in

traffic. Drivers in many major U.S. cities spend more than
40 hours a year in traffic jams. In the San Bernardino-Riverside
underground the city’s major highway and built a new harbor
tunnel, cost more than $14 billion.) Are they worth it? To answer
that question, we need to put a dollar value on the time savings
area of California, the worst in the country, the figure is closer from reduced traffic congestion.8
to 75 hours a year. Similar delays are experienced by drivers in If a commuter gains an hour a week because of reduced
cities such as Toronto, Paris, Mexico City, and Tokyo. traffic congestion, what is it worth to him? Does this depend on
One way that governments try to alleviate traffic jams how he would spend the hour? Would the answer be different
is by building new highways. These projects can be costly. (At depending, for example, on whether he would choose to take
one extreme, the Big Dig in Boston, which expanded and put an extra hour of leisure or work an extra hour to earn more income?

8Time savings is just one component, although usually the most important, of the benefits that arise from these projects. They can also result in improved safety, reduced
air pollution, and reduced fuel use.

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70 Part I Introduction

Fortunately, marginal analysis can help us What is that value? If the commuter is
here. Consider an individual who is allocating not averse to his job, then the value of an
his time between two activities, leisure and extra hour spent working, and therefore the
work, and is free to choose the number of value of saving an hour commuting, is his
hours he devotes to each (he either has a hourly wage, W. What if he instead finds the
job with flexible work hours or can choose marginal hour of work unpleasant? Then
among jobs with different numbers of hours). that hour will be worth less than W since
The No Marginal Improvement Principle tells the benefit from working an extra hour is the
us that if he is allocating his time optimally, wage rate less the displeasure from work.9
then his marginal benefit of leisure must equal In fact, studies that estimate individuals’
its marginal cost. The marginal cost of leisure values of time typically find values equal
is an opportunity cost—the lost benefit from to about half of their wage rates, indicating
not being able to spend that hour at work, that people are averse to work, at least on
earning more money. Thus, the No Marginal the margin.
Improvement Principle tells us that the value Measured in this way, the value of time
A Los Angeles traffic jam
of that extra hour saved in commuting equals lost due to traffic congestion is enormous. For
the value he would derive by using it to work. example, a study by the Texas Transportation
Therefore, to figure out the benefit of reduced commuting, it Institute estimated that in 2010 the time lost by individuals
doesn’t matter whether a shorter commute leads to more work or traveling in passenger cars due to traffic congestion in the United
more leisure. On the margin, their values are the same. States was worth more than $73 billion.

as we did in Table 3.3. With more choices, but still a limited number, we could create
a spreadsheet. However, when choices are finely divisible, it is often both quicker and
more exact to find the best choice by applying the No Marginal Improvement Principle.
From the No Marginal Improvement Principle we know that, in searching for a
best choice, we can limit our attention to activity levels at which either (a) MB 5 MC,
or (b) it is impossible to both increase and decrease the activity level. Often, there are
only a few activity levels that satisfy these conditions, and we can find the best choice
by comparing the net benefit levels for each of them. Worked-Out Problem 3.1 shows
how to do this for your car repair problem.

WORKED-OUT PROBLEM 3.1

The Problem Suppose that you can hire a mechanic to work on your car for
up to six hours. The total benefit of repair work is B(H ) 5 654H 2 40H 2 and the
total cost is C(H ) 5 110H 1 40H 2, where H is the number of hours. The marginal
benefit is MB(H ) 5 654 2 80H and the marginal cost is MC(H ) 5 110 1 80H.
What is your best choice?
The Solution Any number of repair hours, H, at which MB 5 MC solves the
equation
654 2 80H 5 110 1 80H
9Matters are more complicated if the commuter can’t adjust the amount of time he spends working. For example, if he must
work 40 hours a week, then the marginal benefit from other activities need not equal the value he derives from his last hour of
work (that is, the No Marginal Improvement Principle for Finely Divisible Actions does not apply). In that case, the value of
the hour saved in commuting could, in principle, exceed his hourly wage.

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Chapter 3 Balancing Benefits and Costs 71

The only solution to this equation is H 5 3.4. So the best choice is either 3.4 hours,
0 hours (since it is then impossible to reduce hours), or 6 hours (since it is then
impossible to increase hours). Your net benefit is $924.80 for H 5 3.4, $0 for
H 5 0, and $384 for H 5 6 (in Table 3.3 we rounded this $384 to the nearest $5).
So your best choice is to hire your mechanic for 3.4 hours.

IN-TEXT EXERCISE 3.3 Suppose that you can hire a mechanic to work on your car
Want the video or
for up to six hours. The total benefit of repair work is B(H ) 5 654H 2 40H 2 and the text solution? Visit
total cost is C(H ) 5 110H 1 24H 2, where H is the number of hours. The marginal www.mhhe.com/
bernheim2e or
benefit is MB(H ) 5 654 2 80H and the marginal cost is MC(H ) 5 110 1 48H. scan here. Need a
What is your best choice? barcode reader? Try
ScanLife, available in
your app store.
The Appendix to this chapter discusses further how to use the No Marginal
Improvement Principle to find a best choice.

3.3 SUNK COSTS AND DECISION MAKING

Sometimes a decision is associated with costs that the decision maker has already
incurred or to which she has previously committed. At the time she makes her choice,
they are unavoidable regardless of what she does. These are called sunk costs. For A sunk cost is a cost that the
example, suppose that, in addition to the charges discussed earlier, your mechanic decision maker has already
incurred, or to which she has
has already purchased $500 worth of parts for your car that she can’t return or use previously committed. It is
elsewhere. If you are responsible for the $500 regardless of what you have her do, unavoidable.
then it’s a sunk cost.
A sunk cost has no effect on your best choice, even though it increases total costs.
Figure 3.9 illustrates this point. It shows the same benefit curve as in Figure 3.2(a).
In addition, the light red total cost curve, labeled C, adds a $500 sunk cost to the cost
curve from Figure 3.2(b). (We’ll talk about the dark red total cost curve labeled C9
soon.) The sunk cost shifts the total cost curve up by $500. However, as the figure
shows, the vertical distance between the total benefit curve and the light red total
cost curve is still largest at H 5 3.4. Including the $500 sunk cost, the net benefit is
$424.80 ($500 less than before).
The same point also follows from thinking on the margin: because you must pay
the $500 sunk cost regardless of the number of hours of repair work you choose, it
has no effect on marginal costs. The marginal benefit and marginal cost curves are
exactly the same as they were in Figure 3.7 without the $500 sunk cost, so your best
choice doesn’t change.
In fact, the same conclusion would hold even if the sunk cost was large enough to
make your total cost exceed your total benefit. For example, the dark red cost function
labeled C9 in Figure 3.9 adds a $1,100 sunk cost to the cost function from Figure 3.2(b).
The net benefit from choosing 3.4 hours of repair work is now 2$175.20. Nonetheless,
this is the best you can do; your net loss is even greater with any other choice.
This observation reflects a general point: sunk costs never affect a decision mak-
er’s best choice. They are “water under the bridge,” as the common saying goes. An
implication of this fact is that a decision maker can always make the correct decision
by simply ignoring sunk costs—that is, by pretending they are zero.

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72 Part I Introduction

Figure 3.9 C9
Finding a Best Choice with
a Sunk Cost. This figure shows
a cost-benefit comparison for two B
possible cost curves with sunk
costs. The light red cost curve
has a $500 sunk cost, while Total benefit, total cost ($) –175.20 C
the dark red cost curve has an
$1,100 sunk cost. In both cases,
the best choice is H 5 3.4; the
level of sunk costs has no effect 424.80
on the best choice.
1,100

500

0 1 2 3 4 5 6
3.4
Hours (H)

While sunk costs don’t affect a decision maker’s best choice, the sinking of a
cost can matter. For example, if your total cost is described by the dark red curve in
Figure 3.9, and no parts have yet been ordered, your best choice would be to do no
repair work.10 But once your mechanic has ordered $1,100 worth of parts, your best
choice is to employ her for 3.4 hours.
Application 3.3 provides an example of the importance of ignoring sunk costs.

Application 3.3

The Chunnel—A Really Sunk Cost

I n 1802 Albert Mathieu completed plans for connecting England

and France via a tunnel under the English Channel. Work on
the tunnel began in the early 1880s, only to be abandoned
The ground breaking for the privately financed 31-mile
“Chunnel” occurred in 1987. Construction was expected to last
six years and to cost roughly £3 billion (British pounds). The
after 11,500 feet because of British fears of an invasion. The project’s sponsors anticipated revenue of approximately £4
project languished until 1984, when Prime Minister Margaret billion, and a net profit of £1 billion.11,12
Thatcher of England and President Francois Mitterrand of By 1990, however, prospects did not look so rosy to the
France revived it. Chunnel’s investors. Construction was taking longer than anticipated,

10Read More Online 3.4 discusses costs that are incurred only if you choose a positive activity level (e.g., only if you decide to do some repair work), and are otherwise
unaffected by the level of the activity. These are known as avoidable fixed costs.
11These projected revenues and costs were both uncertain and spread out over time. In Chapters 10 and 11, we will explain how to arrive at total benefit and cost figures
in such cases.
12SeeCarmen Li and Bob Wearing, “The Financing and Financial Results of Eurotunnel: Retrospect and Prospect,” November 2000, Working Paper No. 00/13,
University of Essex.

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Chapter 3 Balancing Benefits and Costs 73

and costs were escalating. The total estimated cost had

risen to £4.5 billion, of which £2.5 billion had already
been spent.
Had the project’s sponsors foreseen these
difficulties in 1987, their best choice would have been
not to even start the project. But the £2.5 billion they
had already spent by 1990 was a sunk cost, both
literally (under the English Channel) and economically.
It could not be recovered. Looking forward, investors
were clearly better off spending another £2 billion to
get the £4 billion in revenue, despite the fact that—
including the costs they had already sunk—they would
Construction of the Chunnel ultimately lose £0.5 billion.

*3.4 CONSTRAINED OPTIMIZATION

Many economic problems we’ll study have the feature that a decision maker faces a
constraint that affects several decisions, requiring that she make trade-offs among
them. For example, the fact that you can’t spend more than is in your bank account
is a constraint that affects both where you go for spring break and whether you buy
a new smartphone. Likewise, consider a consumer who has to decide how much
food and clothing to buy, but has a limited budget to spend. This budget constraint
implies that the more she spends on food, the less of her budget is available for cloth-
ing. In this section, we’ll discuss how to analyze these problems. We’ll see that there
is a close connection to the principles we encountered earlier in the chapter.
Consider again your car repair decision, but suppose now that you have to decide
how much repair time to devote to the engine, and how much to the car’s body. The
total benefit of doing HE hours of engine work is BE (HE), while the total benefit of
HB hours of body work is BB(HB). For simplicity, suppose that all repair work costs
$100 per hour, and that you have a total budget of $1,000 available to spend, so you
can afford 10 hours in total. (Your parents have offered to pay this amount to repair
your car, and you can’t use the money for anything else.)
The problem you face is one of choosing the number of hours to devote to each
type of repair work, HE and HB, to maximize your total benefits, subject to the con-
straint that the total number of hours equals 10. This is an example of a constrained A constrained optimization
optimization problem. We can represent this problem as follows: problem involves choosing
the levels of some variables
Choose HE and HB to maximize BE(HE) 1 BB(HB) to maximize the value of an
objective function subject to
subject to the constraint that HE 1 HB 5 10 satisfying certain constraints.

The first line describes what is called the objective function, here the sum
BE (HE ) 1 BB (HB), while the second line describes the constraint, here the require-
ment that HE 1 HB 5 10.
One way to solve this problem is known as the Substitution Method. The idea is
that we can use the constraint to solve for the value of one variable in terms of the
level chosen for the other, substitute this value into the objective function, and then

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74 Part I Introduction

find the best choice for the remaining variable. To illustrate, from the constraint, we
know that if you get HE hours of engine repair work, then you can afford 10 2 HE
hours of body work. Substituting this expression into the objective function for
HB, we can change the constrained optimization problem into the following uncon-
strained problem:
Choose HE to maximize BE (HE) 1 BB (10 2 HE ). (3)
More generally, if
HB(HE) is the amount The No Marginal Improvement Principle (for Finely Divisible Actions) tells us
of body work you can
afford given HE, we choose HE to that, at a best choice for HE, the marginal benefit from an increase in HE must
maximize BE(HE) 1 BB(HB(HE)). equal its marginal cost. The marginal benefit is MBE (HE ). The marginal cost is
Using the chain rule, the first- an opportunity cost–the benefits you lose because you can’t afford as much body
order condition for this problem
is MEE(HE) 5 MBB(HB(HE))
work. Because you get one less hour of body work for each hour of additional
3 HB9(HE). engine work, this marginal cost equals MBB (10 2 HE). So the best choice of HE
satisfies the condition
MBE (HE) 5 MBB (10 2 HE). (4)
Once you determine the number of hours of engine work HE using formula (4), you
can find the number of hours of body work by using the constraint HB 5 10 2 HE.

WORKED-OUT PROBLEM 3.2

The Problem You need to repair your car. An hour of repair time costs $100
and you have a budget of $1000. The total benefit of HE hours of engine work is
BE(HE ) 5 500HE 2 30(HE )2, which has marginal benefit MBE (HE ) 5 500 2 60HE.
The total benefit of HB hours of body work is BB (HB) 5 500HB 2 20(HB)2, which
has marginal benefit MBB (HB) 5 500 2 40HB. How many hours of engine work
should you get, and how many hours of body work?
The Solution Applying formula (4), the best choice of HE satisfies the
condition
500 2 60HE 5 500 2 40(10 2 HE).
Solving, we see that you should choose HE 5 4 (four hours of engine work).
Since HB 5 10 2 HE , this means that you should get 6 hours of body work.

IN-TEXT EXERCISE 3.4 Consider again Worked-Out Problem 3.2, but suppose
Want the video or
text solution? Visit instead that the total benefit of HB hours of body work is BB (HB) 5 400HB 2
www.mhhe.com/
bernheim2e or
20(HB)2, which has marginal benefit MBB(HB) 5 400 2 40HB. How many hours
scan here. Need a of engine work should you get, and how many hours of body work?
barcode reader? Try
ScanLife, available in
your app store. Economists also have a more powerful tool for solving constrained optimization
problems, known as the Method of Lagrange Multipliers. That method is particu-
larly useful in problems with more than two decisions, more than one constraint, or
constraints that do not allow you to solve explicitly for the value of one decision in
terms of the other. If you know calculus, you can learn more about this method by
studying Read More Online 3.5.

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C H A PT E R S U M M A RY

1. Maximizing benefits less costs 3. Sunk costs and decision making

a. Many economic decisions involve balancing a. A sunk cost should have no effect on a decision
benefits and costs to find a best choice. maker’s best choice. It is “water under the bridge.”
b. A best choice yields the highest net benefit (total A decision maker can always make the correct
benefit less total cost) of all possible alternatives. choice by ignoring sunk costs.
2. Thinking on the margin b. While sunk costs don’t matter for a decision
a. Economists often think about a choice in terms maker’s best choice, the act of sinking a cost—
of its marginal benefit and marginal cost, which which turns an avoidable cost into a sunk cost—
capture the ways that benefits and costs change as can matter.
the decision changes. *4. Constrained optimization
b. The No Marginal Improvement Principle says a. Many economic problems have the feature that
that if an action is a best choice, then a small a decision maker faces a constraint that affects
(marginal) increase or decrease in the activity level several decisions, requiring that she make trade-
can’t increase net benefit. offs among them.
c. When actions are finely divisible, the No b. One way to solve such problems is the Substitution
Marginal Improvement Principle tells us that Method, in which an unconstrained problem is
whenever it is possible to both increase and derived by solving the constraint to determine the
decrease the activity level a little bit starting at a required value of one variable given the choices for
best choice, marginal benefit equals marginal cost the others.
at that choice. c. A more powerful tool for solving constrained
d. The No Marginal Improvement Principle can be optimization problems is the Method of Lagrange
used to help identify best choices. Multipliers.

D I S C U S S I O N Q U E ST I O N S

1. What are the benefits you expect to derive and the the answer is yes, explain why. If you think the answer
costs you expect to incur from studying for the final is no, give an example in which the best choice is
exam in this course? higher when costs are higher.
2. Economist Milton Friedman is famous for claiming 4. Once the Chunnel investors (in Application 3.3 on
“There is no such thing as a free lunch.” What do you page 72) had incurred expenses of £2.5 billion, at
think he meant? what projected total cost would they have decided to
3. “If the cost of repairing your car goes up you should abandon the project?
do less of it.” Is this statement correct? If you think

PROBLEMS*

1.A Suppose that the cost of hiring your mechanic 2.A Suppose that the cost of hiring your mechanic (including
(including the cost of parts) is $200 an hour (she the cost of parts) is $200 an hour up to four hours and
charges for her time in one-hour increments). Your $300 an hour over four hours (she charges for her time
benefits and other costs are the same as in Tables 3.1 in one-hour increments). Your benefits and other costs
and 3.2. Construct a table like Table 3.3. What is your are the same as in Tables 3.1 and 3.2. Construct a table
best choice? like Table 3.3. What is your best choice?

*A 5 Easiest; B 5 More Difficult; C 5 Most Difficult.

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3.B Suppose you can hire your mechanic for up to six lost wages, is C(H ) 5 20H, which implies that your
hours. The total benefit and total cost functions are marginal cost is MC(H ) 5 20. How many hours
B(H ) 5 654H 2 40H 2 and C(H ) 5 110H 1 120H 2. should you spend studying for your exam to maximize
The corresponding formulas for marginal benefit the funds you have available for your trip?
and marginal cost are MB(H ) 5 654 2 80H and 8.A What would be the best choice in Worked-Out
MC(H ) 5 110 1 240H. What is your best choice? Problem 3.1 (on page 70) if you are already committed
4.B Suppose you can hire your mechanic for up to six to paying an additional $1,500 for parts your mechanic
hours. The total benefit and total cost functions are has ordered? What would your net benefit be?
B(H ) 5 420H 2 40H 2 and C(H ) 5 100H 1 120H 2. 9.C Suppose that in addition to the costs in Problem 4,
The corresponding formulas for marginal benefit you have already committed to paying $100 to your
and marginal cost are MB(H ) 5 420 2 80H and mechanic for parts she has ordered.
MC(H ) 5 100 1 240H. What is your best choice? a. Write out your cost function mathematically and
5.C Suppose you can hire your mechanic for up to six graph it.
hours. The total benefit and total cost functions
b. What is your best choice?
are B(H ) 5 400 !H and C(H ) 5 100H. The
corresponding formulas for marginal benefit and c. Suppose your mechanic tells you that she can
marginal cost are MB 5 200/ !H and MC(H ) 5 100. return the parts she has ordered and you wouldn’t
What is your best choice? need to pay the $100 if you do no repair work at
all. What is your cost function now? What is your
6.B The Clearvoice cell phone company is considering
best choice? (Hint: Now if you get no repair work,
investing in additional cell phone towers across the
you can avoid paying the $100 – it is no longer
country to improve its coverage and attract more
a sunk cost. Look at Read More Online 3.4 and
customers. It estimates that if it builds K additional
try using the two-step procedure described in the
towers, its benefit (the value of its increased future
Appendix to find your best choice.)
profits) will be B(K ) 5 500K 2 K 2 million dollars,
with a marginal benefit of MB(K ) 5 500 2 2K. Each d. How would your answers to parts (a)-(c) change if
tower costs 20 million dollars. What is Clearvoice’s the cost of the parts your mechanic ordered had
total cost when it builds K towers? What is its been $200?
marginal cost? Treating its investment as finely *10.B Suppose that in addition to repairing your car, you
divisible, how many cell towers should it build? can also spend money advertising. The benefit of
7.B You are considering how much to study for your H hours of repair work is BR(H ) 5 220H 2 H 2,
microeconomics exam at the end of the week, but all while the benefit of D dollars of advertising is
you care about is your upcoming spring break trip BA(D) 5 2D. The marginal benefit of repair work
to Florida. Fortunately, your parents have offered to is MBR(H ) 5 220 2 2H, while the marginal benefit
contribute $4 toward the cost of your trip for every of advertising is MBA(D) 5 2. Repair work costs
point you get on the exam. You estimate that with H $100 per hour and you have a total of $1,500
hours of studying, your parents’ contribution (your to allocate between repair work and advertising.
total benefit from studying) will be B(H ) 5 40H 2 H 2. a. Write down your constrained optimization problem.
This implies that your marginal benefit with H hours b. What is your best choice of repair hours and
of studying is MB(H ) 5 40 2 2H. But you can also advertising? Interpret the condition that characterizes
earn $20 per hour working at your pizza delivery your best choice in terms of the marginal benefits
job, so your total cost for studying H hours, due to and marginal opportunity costs of repair work.

CA LC U LU S P R O B L E M S *

1.B Suppose that you can hire your mechanic for up to 2.B Suppose that in addition to repairing your car, you
6 hours in finely divisible increments. Your benefit can also spend money advertising. If you repair your
and cost functions are B(H) 5 4000 !H and car for H hours and spend A dollars advertising,
C(H) 5 100H 1 120H2. What is your marginal benefit your benefit (the amount you receive when you sell
when H 5 4? What is your marginal cost? your car) is B(H, A) 5 220H 2 H2 1 2A. Both H
*A 5 Easiest; B 5 More Difficult; C 5 Most Difficult.
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and A are finely divisible. What is your marginal *6.B John is a salesman for the local car dealership. He
benefit of repair hours when H 5 4 and A 5 100? can divide his 40-hour work week between talking
What is your marginal benefit of advertising dollars to customers that walk in the door and calling
at that choice? possible prospects. Let W be the number of hours
3.C Suppose that in addition to repairing your car, each week he spends on walk-ins, and let P be the
you can also spend money advertising. If you number of hours spent on calling prospects. In a
repair your car for H hours and buy A column typical week, the number of cars John sells depends
inches of ads in the local paper, your benefit (the on the time he spends on these tasks as follows:
amount you receive when you sell your car) is N(W, P) 5 0.9W 2 0.01W2 1 0.5P. John earns a
B(H, A) 5 400H 2 10H2 1 200A 2 5A2 1 10AH, bonus of $1,000 for each car he sells.
where H and A are finely divisible. What is your a. Write down John’s constrained optimization
marginal benefit of repair work when H 5 5 and problem.
A 5 4? What is your marginal benefit of advertising b. How should he divide his time between walk-ins
at that choice? How does an increase in advertising and calling prospects?
affect the marginal benefit of repair work? Can you *7.C Suppose that in Calculus Problem 2 repair work costs
think of a reason that might be true? $100 per hour and you have $1,500 to allocate between
4.B Suppose that you can hire a mechanic to work on repair work and advertising. Write down the
your car for up to 6 hours. The benefit of repair constrained optimization problem you face. What
work is B(H) 5 654H 2 112H2 and the cost is is your best choice of repair hours and advertising?
C(H) 5 110H 1 24H2, where H is the number of Interpret the condition that characterizes your best
hours. What is your best choice? choice in terms of marginal benefits and marginal
(opportunity) costs of repair work.
5.B Suppose that you can hire your mechanic
for up to 6 hours. Your benefit and cost *8.C Suppose that in Calculus Problem 3 repair work costs
functions are B(H) 5 420H 2 40H2 and C(H) 5 $100 per hour, ads cost $100 per column inch, and
100H 1 120H2. What are your marginal benefit you have $1,000 that you can spend in total. Write
and marginal cost when H 5 3? What is your down the constrained optimization problem you face.
best choice? What is your best choice?

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