Marginal Benefit and Marginal Cost of airline safety regulations.

A recent post by Michael Cameron on his blog ‘Sex, Drugs and Economics’ looked at the writing of Eli Dourado and the marginal analysis of airline safety. The Federal Aviation Administration (FFA) sets the safety standards for international carriers as well as smaller aircraft and it is within the latter that Dourado focuses on. The FAA in its role can either regulate personal aviation too much or too little and the challenge is finding that ‘optimal zone’ where the level of safety regulation is just right.

Too little regulation = higher risk of fatalities due to an inadequate safety program that is commensurate with the risk.

Too much regulation = less innovation in the industry therefore it is possible that the market will not produce the optimal amount of safety improvements therefore regulation continues. The greater the regulation could mean increased costs and wages for workers.

A balanced approach allows the FAA to meet and/or increase safety objectives while imposing the least burden on industry and society. This is shown in the green shaded area in the Figure below:

Marginal Benefit and Marginal Cost analysis

The economic theory of marginal analysis is similar to that above – marginal benefit and marginal cost. Let’s reconsider the nature of the demand and supply curves and what they illustrate on a diagram. Remember that marginal utility is expressed in money terms and would become an individual’s demand curve. When measured in money terms, the marginal benefit to society, or the marginal utility to consumers, becomes the demand curve. Similarly, the marginal cost to society, or the marginal cost to producers, becomes the supply curve.

The consumers at MB1 are paying more than the utility they are getting for the quantity of as P > MB1, so they will decrease their consumption to Q2 at P = MB. The consumers at MB2 are not maximising their utilities as they will get more utility than what they are paying for the quantity of as P < MB2, so they will increase their consumption to Q2 at P = MB. Therefore, at any given price, consumers will consume at a quantity where P = MB. As a result, the marginal benefit curve and the demand curve are identical. Similarly, suppliers will always produce at a level where the price equals marginal cost at any given price. Because at MC1 they are not maximising their profits as P > MC1; at MC2 they are making a loss as P < MC2. So, the marginal cost curve and the supply curve are identical. This can help you understand the concepts of consumer and producer surplus as they can both choose to consume and produce at a level that will maximise their utilities and profits. And this maximum utility or profit is more or ‘in surplus’ compared to the amount they have to pay.

The FAA’s diagram works similarly. At low levels of safety effort, there is too little rigour. The marginal benefit of additional safety effort is greater than the marginal cost. At high levels of safety effort, there is too little safety innovation. The marginal cost of the additional safety effort is greater than the marginal benefit. Michael Cameron

Source: Wells Yuan – CAIE A2 Level Economics notes – Unit 7

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