Rationality, Opportunity Cost and Marginal Analysis

Concept of Rationality,
Opportunity Cost and

Marginal Analysis
Dr Amir Ullah Khan
Health Economics Evaluation
Video Link - https://www.youtube.com/watch?v=cUgkWYeRsJk
Rational Decisions and Scarcity
A rational decision is not just a decision made by evaluating all choices, it is a

decision that takes into account the reason for making the decision.
Decisions should be made taking individual and national goals into account
because of scarcity.
Scarcity is the concept that people and countries have unlimited wants but
limited resources. This forces people to make choices and when you make a
choice, there is always a cost.
Allocation of scarce resources in
the purest form is a component to
Allocation study human behaviour.
of Scarce It occurs at all levels- individuals,

business firms, markets, and
Economic economies.
Resources
It shows how external and internal
environments interact.
• Substantive Rationality – It is the adjustment to outer
environment
• It involves a choice of means to ends leaded by some
larger system of human values
Types of
Rationality • Procedural Rationality – It is the ability to discover
adaptive behaviors through knowledge and
computation
• Involves real-life interactive decisions like how much to
produce and what to market.
• Problem changes from one of choosing the right course
of action to locating a good action
Rational Choice Theory
Some Systematic Departures from Rational
Choice
Bias 2: Paying
Bias 1: Generosity Bias 3:
Attention to Sunk
and Selflessness Overconfidence
Costs
Bias 4: Self-Control
Problems and Bias 5: Falling Prey
Hyperbolic to Framing
Discounting
8
Opportunity Cost
Opportunity cost is the cost of next best alternative foregone
In simple terms, it is what you give up when you choose to do something else
Every choice is a trade-off. Tradeoffs imply costs – when a decision is made,

something is forgone
Opportunity
Cost for
Different
Economic
Agents
Growth and
Opportunity
Cost: What
price are we
paying for
growth?
Production Possibility Frontier and Opportunity Cost
The Production
Possibilities Frontier (PPF)
is a graph that shows all
the different
combinations of output of
two goods that can be
produced using available
resources and technology.
Assumptions for PPF
Resources in an economy is fixed, but these resources can be transferred from one use
to another.
With the help of given resources, only two goods can be produced.
The resources are fully and efficiently utilized.
Resources are not equally efficient in production of all products. So, when resources
are transferred from production of one good to another, the productivity decreases.
Healthcare vs
Education : A
policy dilemma
The Scarcity Problem
What to produce?
• What should be made using available resources?
How to produce?
• What combination of resources should be used?
Who will consume?
• How will production be allocated?

Marginal Analysis
Marginal analysis is used in allocating scarce resources to maximize the benefit of

the output produced by simply getting the most value for the resources used
The analysis of the benefits and costs of the marginal unit of a good or input
(Marginal = the next unit)
In any situation, people want to maximize net benefits
Net Benefits = Total Benefits - Total Costs

Marginal Decision Making
Most decisions are made incrementally – costs and
benefits are weighed at each step
Examples
How clean is clean How long should a student How many tractors and
enough? study? cars should be produced?
Marginal Analysis- Environmental
Protection
• Reducing pollution is costly, it will

cost resources.
• The marginal costs of reducing
pollution are generally increasing,
because the least expensive and easiest
reductions can be made first, leaving
the more expensive methods for later.
• The marginal benefits of reducing
pollution are generally declining,
because the steps that provide the
greatest benefit can be taken first, and
steps that provide less benefit can wait
until later.
Discussion Questions
Is rationality principle same for all economic agents?
What should be the strategies for allocating scarce resources?
Can you think of tools or methods to make rational decisions?

Readings
• Simon, H. A. (1959). Theories of Decision-Making in Economics and Behavioral Science. The
American Economic Review, 49(3), 253–283. http://www.jstor.org/stable/1809901
• Mitton C., Dionne F, & Donaldson C (2014). Managing Healthcare Budgets in Times of Austerity:
The Role of Program Budgeting and Marginal Analysis. Appl Health Econ Health Policy 12, 95–102.
https://doi.org/10.1007/s40258-013-0074-5
• Column- https://economictimes.indiatimes.com/news/economy/policy/india-has-to-get-back-to-
business-marginal-cost-is-far-exceeding-the-marginal-benefit/articleshow/75146003.cms

Rationality, Opportunity Cost and Marginal Analysis

Uploaded by

Copyright:

Available Formats

Rationality, Opportunity Cost and Marginal Analysis

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Rationality, Opportunity Cost and Marginal Analysis

Uploaded by

Copyright:

Available Formats

Concept of Rationality,

Opportunity Cost and

A rational decision is not just a decision made by evaluating all choices, it is a

of Scarce It occurs at all levels- individuals,

Opportunity cost is the cost of next best alternative foregone

Every choice is a trade-off. Tradeoffs imply costs – when a decision is made,

The resources are fully and efficiently utilized.

• What should be made using available resources?

• What combination of resources should be used?

Who will consume?

• How will production be allocated?

Marginal analysis is used in allocating scarce resources to maximize the benefit of

In any situation, people want to maximize net benefits

Net Benefits = Total Benefits - Total Costs

• Reducing pollution is costly, it will

Is rationality principle same for all economic agents?

What should be the strategies for allocating scarce resources?

Can you think of tools or methods to make rational decisions?

You might also like