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Often in class, I have heard professors make the claim that "at the margin, it is optimal to do so and so." One clear example of the importance of marginal analysis is when looking at the profit maximizing decision. In other words, firms do not randomly choose a quantity to produce as long as Cost is lower than Benefit, but rather, one that maximizes the difference. On the other hand, when looking at feasibility studies, we concern ourselves solely with the present value of costs and benefits, and do not worry ourselves about marginal decisions. Are there any "rules of thumb" or principles that guide our decision to choose marginal analysis over overall costs vs. benefits?

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Which type of analysis is relevant depends on the type of question it is used to answer.

If the question is "How much of x would be optimal?", then it needs marginal analysis.

If the question is "Should this (well-defined) project go ahead or not?", then it needs consideration of overall costs and benefits (with appropriate discounting if the costs and/or benefits will be spread over a number of years).

The point about the project being well-defined is important here. Often, decisions about possible projects also involve an element of "how much", for example:

  • Should a tower block be built and if so how many storeys should it have?
  • Should a power station be built and if so what should its capacity be?

Decisions such as these may require a combination of marginal analysis, to determine the optimal (non-zero) value of the relevant variable, and then consideration of overall costs and benefits, to assess whether, assuming that optimum, the project should go ahead at all.

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  • $\begingroup$ In addition to your answer the "NPV of a project is positive" criterion is often interpreted as a positive marginal change at the level of the macro-economy, because the project is just a small change relative to the full economy. In this way the social cost benefit analysis can be applied iteratively to achieve the "optimum" and is marginal analysis in its own right $\endgroup$ May 23, 2023 at 10:53

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