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Cost-Benefit Analysis

Definition

Cost-benefit analysis is a decision-making tool that compares the costs of an action or project with its potential benefits. It helps individuals and businesses determine whether the benefits outweigh the costs, allowing them to make informed choices.

Analogy

Imagine you want to buy a new video game console. Before making a decision, you compare the cost of the console with the enjoyment and entertainment it will bring. If the benefits (fun, excitement) outweigh the costs (price), then it's worth buying.

Related terms

Opportunity Cost: The value of the next best alternative that is given up when making a choice. For example, if you choose to go to a concert instead of studying for an exam, your opportunity cost is potentially getting a lower grade on the exam.

Marginal Benefit: The additional benefit gained from consuming one more unit of a good or service. For instance, eating one slice of pizza may give you satisfaction, but each additional slice may provide less marginal benefit.

Sunk Costs: Costs that have already been incurred and cannot be recovered. An example would be purchasing tickets for a concert but then deciding not to attend. The money spent on those tickets becomes sunk costs because it cannot be refunded.