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Cost-Benefit Maximizing Principle

Definition

The cost-benefit maximizing principle is the idea that individuals or firms should take an action if the marginal benefit of that action exceeds the marginal cost, and they should avoid taking an action if the marginal cost exceeds the marginal benefit.

Analogy

Imagine you are deciding whether to buy a new video game. You consider how much enjoyment you will get from playing it (the benefit) and how much money it costs (the cost). If the enjoyment you expect to get from playing the game outweighs its price, then according to the cost-benefit maximizing principle, you should go ahead and make the purchase.

Related terms

Opportunity Cost: The value of the next best alternative that must be given up when making a decision. For example, if you choose to spend your money on a video game, your opportunity cost could be not being able to afford going out with friends.

Marginal Analysis: The process of comparing additional benefits and costs when making decisions. It involves evaluating whether the extra benefit gained from one more unit of something is worth its additional cost.

Sunk Cost: A cost that has already been incurred and cannot be recovered. When applying the cost-benefit maximizing principle, sunk costs should not be considered because they are irrelevant for future decision-making.