Many economic decisions involve balancing benefits and costs to find a best choice.
A best choice yields the highest net benefit (total benefit less total cost) of all possible alternatives.
Thinking on the margin
Economists often think about a choice in terms of its marginal benefit and marginal cost, which capture the way benefits and costs change as the decision changes.
The No Marginal Improvement Principle says that if an action is a best choice, then a small (marginal) increase or decrease in the activity level can't increase net benefit.
When actions are finely divisible, the No Marginal Improvement Principle tells us that whenever it is possible to both increase and decrease the activity level a little bit starting at a best choice, marginal benefit equals marginal cost at that choice.
The No Marginal Improvement Principle can be used to help identify best choices.
Sunk costs and decision making
The size of a sunk cost has no effect on a decision maker's best choice. It is "water under the bridge." A decision maker can always make the correct choice by ignoring sunk costs.
While sunk costs don't matter for a decision maker's best choice, the act of sinking a cost—which turns an avoidable cost into a sunk cost—can matter.
