Question

The economy works via the interactions of economic agents (interactions of economic choices). Economists claim that pursuing self-interest based on our skills leads to trade based specialization and mutual gains from trade.

1. Think of a recent purchasing decision in which you compared the marginal benefits associated with buying a product with the marginal costs. How do you make a rational decision by comparing marginal benefits and marginal costs?
2. What is the role of self-interest in free market operations (economic choice interactions)? Why engagement in self-interest may lead to better welfare for the society?

Answer 1

Ans a)

The marginal benefit is the addition to the total benefit that one derives from the consumption of an additional unit of good.

Similarly marginal cost is the addition to the total cost when an additional unit of good is produced.

The marginal benefit largely resonates with the consumer and marginal cost resonates with the producer.

Both consumer and producer tend to maximize their satisfaction from the economic interactions that happen in the market.

Marginal benefit simply means the maximum amount that an individual is willing to pay for a good.

If I as a consumer consider both marginal benefit and marginal cost of purchase of a good, then I would prefer to buy a good until both the marginal benefit and marginal cost equal. Marginal cost could be caused related to the searching of good, travelling and time involved related to search of a good.

In the diagram below, the equilibrium point occurs where both the marginal benefit and marginal cost curve intersect where the equilibrium quantity is Q and equilibrium price is P.

CO MC MB Quantity

Ans b)

Self interest are the actions that individuals take in order to maximize their utility or gains from the trade.

Adam Smith, the father of Economics explain that when every individual in the economy makes rational decisions based on self interest then it leads to the overall Welfare of the economy.

We all possess some resources in terms of land, capital which we trade rationally with other economic agents for the purpose of deriving financial and intrinsic satisfaction.

In today's capitalist system, a market economy where goods and services are exchanged, the economic agents are the consumers and producers who voluntarily trade with each other in order to pursue their self interest. This indirectly leads to the benefit for the whole society.

Adam Smith has used a popular term "The Invisible hand" for this concept which also means that overall benefit is increased when each individual behaves rational.