Question

Milton Friedman, a well-known economist, claimed that perhaps the biggest mistake people and policymakers make in their economic decision is basing decision on average benefits and costs (rather than on marginal benefits and costs). Why is important in economics to focus more on marginal costs and benefits rather than average costs and benefits?

Answer 1

Marginal analysis is helpful in determining the extent to which an economic activity should be done which is impossible to be done by average analysis. Marginal means one additional. Therefore, when an economic activity is undertaken, such as the production of a particular good, marginal analysis is used to find the optimal level of output at which the cost of producing an additional output is compared with the benefit of producing it. This indicate that marginal benefits and marginal costs are used to analyse how economic decisions should be taken.

Average costs and benefits fail to allocate resources efficiently in this manner because average analysis does not indicate how much a resource is likely to benefit or cost one additional individual. Instead it informs how on average every individual will be affected.

Due to this difference economics use marginal costs and benefits instead of average benefits and costs.