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Allocative efficiency and marginal benefit

Marginal Utility and maximization. Created by Sal Khan.

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  • blobby green style avatar for user yessi.oseguera
    So wait if MB is what you are willing to pay what is MC?? I got a little lost in the process.
    (16 votes)
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    • spunky sam blue style avatar for user Nick Dolan
      Ok...the MC (Marginal* Cost) is something that can be determined mathematically: it is essentially equivalent to the opportunity cost, aka what you are giving up in the pursuit of one more unit. The MB (Marginal* Benefit) is something that cannot be determined mathematically: this is where the person/company/nation graphs their OPINION on how much they'd be willing and able to give up for one more unit of the product at hand, in this case rabbits. The point where these two lines meet (if they meet) is the point where both parties should(?) be able to reach an agreement. Because the MB and MC are equal, the reason for trade would be b/c Person A prefers gathering object A to hunting object B, or vice versa, and the Person B prefers gathering/hunting the opposite of what Person A prefers.

      *Marginal="relating to goods or services produced and sold at the margin of profitability" [Dictionary.com]

      Hope this helps.
      (83 votes)
  • leaf blue style avatar for user Scott Jang
    I don't understand Allocative Efficiency part. I watched like 5 times and still don't what is it?
    (8 votes)
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    • aqualine seedling style avatar for user Steven Jin
      Erm...The way I see it, it's the way in which to allocate your time most efficiently. So (uh, how do I explain this)...say I have a project and a test, both due for 3 days from now. If I work too long on the project, I might not know everything I need to know for the test. Similarly, studying too long for the test will probably mean I do a half baked job of the project. Allocative efficiency is achieved when I reach the point where I'm fine with both grades, or (to put it another way) when I think I'm giving up too much for one grade over the other, and vice versa. This can be expressed in the form where Marginal Cost= Marginal Benefit.

      Going back to my (admittedly bad) grades example, let's say that with my current scheduling, I'll get a 100 on the test and a 60 on the project. If I work one more hour on the project, I'll lose some time to study on the test (b/c I'm working on the PPF, at full efficiency). That loss of study time means that my grade on the test will drop by 10 points. However, this also means that my grade on the project will rise by 10 points. That doesn't sound so bad to me; in fact it sounds good, because I'm fine with a 90 on the test (I want at least an 80), and I'm happier with a 70 on the project. (Let's say I want an 80 here too.)

      This represents a point where the MB is higher than the MC, because I'm willing to give up more than what it costs.

      Let's jump to the point where I reach allocative efficiency. In my example, I would think it's when I have an 80 for both the project and the test. (Correct me if I'm wrong, please.) At this point, to work longer on the project would be too much of a cost to me, because my grade would drop below what I'm willing to give up (it'd drop below 80, and I want at least an 80). Similarly, I don't see any point in studying more for the test. Thus, I've reached a point where the MC (what I give up) = MB (what I'm willing to give up). At this point, I've figured out what I need to do to allocate my time for the best scenario in my opinion: allocative efficiency. Hope this helped.
      (90 votes)
  • leaf green style avatar for user Ishan Singla
    I got a little confused between the definitions of marginal cost and opportunity cost.please help
    (3 votes)
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  • old spice man green style avatar for user Dania  Zaheer
    how Did he calculate the Marginal Benefit starting from 8.46 ?
    (3 votes)
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  • leafers ultimate style avatar for user Alazar
    I thought it was called marginal utility, not marginal benefit?
    (3 votes)
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  • blobby green style avatar for user Nikola Gladovic
    So, marginal benefit is marginal revenue later, am I right?
    (3 votes)
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  • aqualine sapling style avatar for user Isaak
    what if at the end of the day you got 5 rabbits and on your way home and you just so happen to stumble across another rabbit. Then wouldn't that turn the impossible area into an extremely unlikely area?
    (3 votes)
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    • starky ultimate style avatar for user Geoff Ball
      I can see where your question is coming from, and it's a good one. The PPF works on a set of assumptions and conditions. Very crucially, it assumes that these results are all that is possible. There are no "accidental" rabbit or berry discoveries. The example used is a very basic one to help explain the concept. As you get more advanced, you will consider firms (businesses) and their production trade-offs. Just as Apple cannot stumble upon 1 million iPhones it didn't think it was able to produce, the hunter/gatherer cannot stumble upon a rabbit. With that said, it's good you're thinking critically about what you're learning. Questioning what might normally be "assumed" or considered basic is a key to learning and discovery.
      (4 votes)
  • primosaur ultimate style avatar for user Julia Pockat
    Wouldn't catching rabbits be more profitable because rabbits provide more energy (calories) than berries?
    (3 votes)
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  • male robot hal style avatar for user .
    I understand that you must be inside the PPF, but can one get 5 rabbits AND one berry? Say a berry falls into the person's pouch when he is hunting rabbits or something like that. Would this sort of situation not be considered?
    (3 votes)
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    • starky ultimate style avatar for user A L
      Good question. I don't think so, because in this scenario, the person isn't really making an effort to get that one berry, so there aren't any resources used to get it. Therefore, the person isn't giving up anything to get that berry and so it wouldn't count.
      (3 votes)
  • aqualine seed style avatar for user Rods Shibs
    Why would it be more beneficial for the hunter/gatherer when the MC=MB wouldn't it be better if the MC is less than the MB as he has to lose less and get paid more.
    (2 votes)
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    • piceratops ultimate style avatar for user Zakary Hambsch
      It would be beneficial for the hunter/gatherer to remain at a point at which MC is lower than MB, but that is not possible with this person actually taking advantage of the benefit. For example, at scenario F, he has no rabbits and the difference between the MB and the MC is a 80 berry benefit. He wants to take advantage of this benefit, so he catches a rabbit. As soon as he catches this rabbit, he has now moved to scenario E, in which he has 1 rabbit. He, once again, would be benefited by catching another rabbit (by 40 berries), so he does so and moves himself to scenario D, in which he has 2 rabbits.

      At this point, it doesn't make sense for him to continue to increase the amount of rabbits he catches, because there is no net benefit. At the beginning there was a net benefit (meaning MB was greater than MC), but you cannot both take advantage of that benefit and keep the difference between MB and MC the same. Doing one thing has repercussions on the other.
      (4 votes)

Video transcript

We've already spent a lot of time thinking about these six different scenarios, all of which sit on the production possibilities frontier, which means that in any of these scenarios, we have achieved productive efficiency. And it's true not just of these scenarios. It's true of any of the points on this curve. So you have achieved, any point on that curve, productive-- let me give ourselves some real estate on the right-- efficiency. Which means, another way to think about it, is that as soon as you're at any point on that curve, if you want any more of one of these things you have to give up some of the other. So for example, if you're at point C, and if you want more rabbits, if you want 1 more rabbit, you're going to have to give up some berries. Or if you're at point C and you want more berries, you're going to have to give up some rabbits. And that's true of any point on the production possibilities frontier. A point over here-- let me do this in a different color. So let's say at this point right over here, you have not achieved productive efficiency here because you can get more rabbits without having to give up any berries. And you could get to Scenario B. Or you could get more berries and not have to give up any rabbits, and you would get to Scenario D. So this right over here is inefficient. Now, all of these, that's all good. All of these five or six scenarios, we've achieved productive efficiency. But which of these do we pick? How do we decide to allocate our time? So what I want to talk about in this video is allocative efficiency. And it's somewhat subjective, based on the preferences of, if we are the hunter gatherer, based on our preferences. But at least it gives us a framework for thinking, which of these meets our preferences the best. And to do that, I will review a little bit from the last video. In the last video, we talked about the marginal cost of each incremental rabbit. Or we said the opportunity cost of each incremental rabbit, and the opportunity cost of one incremental unit, that really is just the marginal cost. So let's just write these different scenarios. So let's write the scenarios, scenario for short, scene for short. And then let's think about the marginal cost of 1 incremental rabbit. I'll just draw a rabbit here. And it's going to be given in berries. All right. Let's start with Scenario F. And this is all review from the last video. Sitting in Scenario F, if we want to get 1 extra rabbit, we are going to have to give up 20 berries. In Scenario E, if we're sitting in Scenario E, and we want even 1 more rabbit we now have to give up 40 berries. So the marginal cost at that point of 1 more, I keep wanting to say squirrel, 1 more rabbit is 40 berries. Now let's go to Scenario D. And I encourage you to pause and do this yourself. It'll help if you kind of work it out. Scenario D, the cost of 1 extra rabbit is now 60 berries. You go to Scenario C. The cost is now 80 berries. So in Scenario C the cost is now 80 berries. Finally you got to Scenario B and the cost of, sitting in Scenario B, of getting 1 extra rabbit-- you're going to have to give up 100 berries. And I won't even go into Scenario A, because it will be impossible for you to have any more rabbits and you have no more berries to give up. So these are all the possible scenarios and the marginal costs of them. And we can actually plot them on a line. So let me do that right over here. This will be useful. So let me draw one axis right over here, one axis over here. And this is, let's call this the different scenarios. So this-- let me do in the same order. Let's call this Scenario F, Scenario E. I'll just do it in one color right now. Scenario E, Scenario D, Scenario C and Scenario B. Actually, let me-- instead of doing it that way, let me just talk about it in terms of the number of squirrels I have. So the number of squirrels that I have. So in Scenario F, if you remember, in Scenario F-- oh, not squirrels, rabbits. In Scenario F you have 0 rabbits. Scenario F you have 0 rabbits. So let's say 0, 1, 2, 3, 4, and 5. And so this is the number of rabbits, not squirrels, the number of rabbits that you right now are able to catch, on average, each day. And then in the vertical axis, right now, I want to put the marginal cost in berries. And let's see, it goes from 20 up to 100. So let's say that this is 20, 40, 60, 80, and 100. So Scenario F, that's when we had 0 rabbits. And the marginal cost of trying to get another rabbit, you would have to give up 20 berries. So that is Scenario F right over there. Scenario E, that's one where we had 1, where we already had 1 rabbit and we are thinking about the marginal cost of getting another one. So that's scenario E, is right over there. This is scenario D. Marginal cost is 60. We already have 2 rabbits and we are thinking about getting a third. That's Scenario D. And then Scenario C, we already have 3 rabbits, thinking about getting a fourth. That's Scenario C. And then finally, we have Scenario B where we already have 4 rabbits and we're thinking about getting a fifth. And we would have to give up 100 berries to get that fifth rabbit. So that's Scenario B right over there. So what I've just done is plotted the marginal cost along-- these are points on, essentially, our marginal cost curve, our marginal cost as a function of the number of rabbits we have. So let me connect all the dots. And then this scenario just happened to be a line. Doesn't always have to be a line but in many introductory economics courses, it's often a line for simplicity. So let me make this a line right over here. This is our marginal cost as a function of the number of rabbits we have. And actually, I should probably draw this axis, I should probably draw-- let me copy and paste this. So let me cut this. Let me cut that and then let me paste it, because it really should sit on the 0 point right over there. And ignore that little line right over there. So there you have marginal cost as a function of berries. But we still don't know which scenario to pick. And to think about that, I want to introduce something called the marginal benefit. And I'll write it as MB, the marginal benefit of an incremental rabbit. And once again, we're going to write it in berries. And the way to think about the marginal benefit is, if we are the hunter-gatherer we're saying, if we're sitting in one of these scenarios, how much would we paid to some hypothetical convenience store in berries-- maybe that convenience store only sells bunnies and they only accept berries-- how much would we pay to them in berries for an extra rabbit? And let's not even look at this thing right over here. So if we're sitting in Scenario F, we're sitting in Scenario F. And you remember Scenario F is right over here. We have no rabbits. How much would we be willing to pay? We have no rabbits and we actually have a ton of berries. So in Scenario F right here, we have no rabbits and we have 300 berries. If we have no rabbits and a lot of berries, let's say, we'll say, we have a lot of berries. We might be in the mood for a rabbit. We would be willing to pay a lot in berries for a rabbit. So let's say we would pay 100. We would pay 100 berries to that hypothetical convenience store for a rabbit. Now let's say that we're in Scenario E. We're in Scenario E, how much would we pay to that hypothetical convenience store? Well, in Scenario E we already have 1 rabbit and we have fewer berries. So we need a rabbit less and we have fewer berries to give, so we're not willing to give quite as many berries for another rabbit. So maybe we'll only give 80 berries. Then you go to Scenario D. We already have 2 rabbits and we have even fewer berries so we're willing to give even fewer berries for another rabbit. This is what we would pay to a convenience store, just based on thinking about it, our current preferences. Then we can go all the way to Scenario C. And it is subjective. It's not like a measurable thing. It's just based on this person's preferences, this hunter-gatherer's preferences. Scenario C, well, they already have more rabbits, even fewer berries. So they'll pay even less. And then finally Scenario B. They have a good number of rabbits and even fewer berries. They would be willing to pay very little for an incremental rabbit. So let's plot the marginal benefit as a function of the number of rabbits that they already have. So if we go to Scenario F, the marginal benefit, doing that little thought experiment is 100. In Scenario E, the marginal benefit, how much you would hypothetically be willing to pay in berries, is now 80 berries. In Scenario D it is 60 berries. In Scenario C it is 40 berries. So Scenario C is right over here. So in Scenario C it's 40 berries. And then in Scenario B it is 20 berries. So in Scenario B it is 20 various, just like that. So now we're not just plotting the marginal cost. We're plotting the marginal cost and the marginal benefit in berries. And the marginal benefit curve-- and it's really a line here, once again, for simplicity-- looks like that. Now, given this-- so this is the marginal benefit curve. Marginal benefit is a function of the number of rabbits that we already have. And this is the marginal cost as a function of the number of rabbits we already have. And so when I say E, this is actually Situation E. That's Situation D. This is also Situation C and this is also-- this is the marginal benefit at Situation B. So given this, what would I rationally do? If these really are my preferences, what would I rationally do? So if I'm sitting here in Situation F, I have no rabbits. I already know that it would cost me 20 rabbits to try to get an incremental one. But I've already said that I'd be willing to pay 100. Sorry, it would cost me 20 berries to get an incremental rabbit. But I've already said that I'm willing to pay 100 berries to get an incremental rabbit. So I would want to move along the curve. So I would definitely want to get more rabbits. I said that I'm willing to pay 100 berries for a rabbit and it would only cost me 20 berries for a rabbit. So I'm saying that I want to get more rabbits. And another way to look at this visually, marginal benefit is much higher than marginal cost here. So I'm willing to go forth and try to get more rabbits. That's even true in Scenario E. The marginal benefit of an incremental rabbit is worth much more to me than the marginal cost, so I'm willing to try to get more rabbits. So in Scenario E I'm still trying to get more rabbits. I still want to move along the production possibilities frontier in this general direction. Now what happens as I get closer to D? So if I'm in this scenario right over here, and this isn't one of our labeled scenarios, but if I'm right over there-- still, my marginal cost is lower than my marginal benefit. So I'll still want to get more rabbits, all the way until I'm Scenario D. In Scenario D I'm a little bit neutral. I'm willing to pay 60 berries for a rabbit, but that's exactly how much I'd have to give up to get that extra rabbit. So let's just think about Scenario D for a little bit. I'll just circle it right over here. Because it looks kind of interesting. Now, let's go-- now would we want to do anything beyond Scenario D? So if I'm at this point right over here, if I'm working enough on average, to say get 2 and 1/2 rabbits a day, would I-- does this make sense for me to try to get any more rabbits? Well, at that point the benefit of getting an incremental rabbit is smaller than the cost of getting a rabbit. At that point, if I try to get another rabbit, I'm getting less benefit from it than the cost associated with it. So I definitely don't want to move past D. So I achieve allocative efficiency where my marginal cost and my marginal benefit is equal. So based on the way that I've rigged the numbers in this example right over here, you want to settle on Scenario D. We have achieved allocated efficiency over there. The marginal cost as a function of our rabbits and the marginal benefit of our function of rabbits is equal.