Marginal Thinking
“Is it worth it?”
The Margin
Is it worth it?
A thing worth doing may not be
worth doing well.
 Know when it’s time to move
on!
Look forward, not back!
When is enough enough?
MARGINAL
• Additional, difference
• What is the marginal benefit between a
regular order of fries and a giant order of
fries? What is the marginal opportunity cost?
• What is the marginal benefit of an additional
15 minutes of sleep? What is the marginal
opportunity cost?
• Marginal benefit/marginal cost analysis
compares the additional benefit of another
unit of the product or activity to the additional
opportunity cost.
Unfortunate consequences of
scarcity
• You will never be the best parent you could
be.
• You will never be the best student you could
be.
• You will never be the best spouse you could
be.
• I will never be the best teacher I could be.
• Maximize your LifePointAverage, when
working on your GPA!
Using Marginal Benefit/
Marginal Cost Analysis
• Investigating two alternatives
• What’s the difference in benefits between the
two?
• What’s the difference in opportunity cost
between the two?
• Is the marginal benefit of the choice greater
than the marginal opportunity cost?
• Is this the best use of additional resources?
What is the benefit and what
is the opportunity cost?
• How good a parent are you?
– Your daughter has a hockey game and
your boss has called n “emergency”
meeting. (MB and MOC)
• How good a student are you?
– You have a test tomorrow and your boss
says she needs you at work. (MB and
MOC)
What is the benefit and what
is the opportunity cost?
• How good a spouse are you?
– Your wife wants you to go to her mother’s
with her but you really need to write the
term paper. (MB and MOC)
• How good a teacher will I be?
– I want to prepare a lesson plan but my son
is asking for help with algebra. (MB and
MOC)
Marginal Analysis
•
We try to make the best use of our scarce
resources by using them in particular
activities (work, parenting, spousing) as long
as the marginal benefit is greater than the
marginal opportunity cost.
• We attempt to maximize our Life Point
Average, not just our GPA or our income, or
any other single goal. We try to do our best
with the “basket” of goals.
Cleaning the brown lake
•
•
•
•
The lake is dirty.
Let’s clean it.
How clean?
What are the benefits of different
degrees of clean?
• What is the marginal opportunity cost?
The relevant questions
• If I put one more hour of human capital
into studying,
– what difference will it make to my grade
(benefit), and
– what difference will it make to my children
in the short run (cost)?
• Is the additional studying the best use of
my limited human capital, based on my
estimates of net benefit?
Juan or George?
Marginal Analysis –What’s the
difference?
• Marginal is the change the results from a little
more or a little less of an activity
• When comparing two alternatives – what is
the marginal benefit and the marginal
opportunity cost of both alternatives?
• You only use marginal analysis when
comparing two alternatives.
• Is the marginal benefit worth what I will be
giving up?
Marginal Opportunity Cost
Hershey’s or Hershey’s with Almonds
•More
chocolate
•Almond
s
•
A
•Chocolat
e
•C
•
B
Marginal Opportunity Cost
•
A
•C •
B
Marginal Opportunity Cost
•
A
•C•
B
The Marginal Principle
• How far should I pursue any single
activity, knowing that the resources I am
using have opportunity costs; they could
be doing other things?
• If
Marginal benefit – marginal cost
Round 1
Round 2
Round 3
Round 4 Round 5
$1.50
•MC
•MB
$1.00
Marginal benefit – marginal cost
Round 1
Round 2
Round 3
Round 4 Round 5
$1.50
•MC
•MB
$1.00
Marginal benefit – marginal cost
Round 1
$1.50
Round 2
Round 3
Round 4 Round 5
$1.45
•MC
•MB
$1.00
$1.20
Marginal benefit – marginal cost
Round 1
$1.50
Round 2
Round 3
Round 4 Round 5
$1.45
$1.35
•MC
•MB
$1.00
$1.20
$1.25
Marginal benefit – marginal cost
Round 1
$1.50
Round 2
Round 3
Round 4 Round 5
$1.45
$1.35
$1.32
•MC
•MB
$1.27
$1.00
$1.20
$1.25
Marginal benefit – marginal cost
Round 1
$1.50
Round 2
Round 3
Round 4 Round 5
$1.45
$1.35
$1.32
$1.30
•MC
•MB
$1.27 $1.29
$1.00
$1.20
$1.25
Marginal benefit – marginal cost
Round 1
$1.50
Round 2
Round 3
Round 4 Round 5
$1.45
$1.35
$1.32
$1.30
•MC
•MB
$1.27 $1.29
$1.00
$1.20
$1.25
How many rounds to play?
Round
1
2
3
4
5
6
Marginal
Benefit
$1.50
$1.45
$1.35
$1.32
$1.30
$1.25
Marginal
Opportunity
Cost
$1.00
$1.20
$1.25
$1.27
$1.29
$1.35
Marginal Net
Gain
$.50
Total Gain
$.50
How many rounds to play?
Round
1
2
3
4
5
6
Marginal
Benefit
$1.50
$1.45
$1.35
$1.32
$1.30
$1.25
Marginal
Opportunity
Cost
$1.00
$1.20
$1.25
$1.27
$1.29
$1.35
Marginal Net
Gain
$.50
$.25
Total Gain
$.50
$.75
How many rounds to play?
Round
1
2
3
4
5
6
Marginal
Benefit
$1.50
$1.45
$1.35
$1.32
$1.30
$1.25
Marginal
Opportunity
Cost
$1.00
$1.20
$1.25
$1.27
$1.29
$1.35
Marginal Net
Gain
$.50
$.25
$.10
$.05
$.01
-$.10
Total Gain
$.50
$.75
$.85
$.90
$.91
$.81
How much of a particular
activity? Know when to move
on.
• Pursue activities as long as the marginal
benefit exceeds the marginal opportunity
cost.
• Pursue activities up to the point where
MB = MOC.
• If the marginal benefit of another unit of the
activity is greater than the marginal
opportunity cost, go for it!
• If the marginal benefit of another unit of the
activity is less than the marginal opportunity
cost, stop!
The Marginal Principle:
Pursue all activities up to the
point where:
Marginal Principle
• MB greater than MOC, go for
it!
• MB less than MOC, go back;
you have gone too far.
Marginal Analysis in
Allocating Society’s
Resources
Marginal Value of Penalties
•(1)
•Alternative
•1
•(2)
•Penalty
for
carrying
•(4)
•New
beds
needed
•(5)
•Total
Cost
($mil)
•(6)
•Marginal
Cost
($mil)
•0
•0
•0
•(3)
•Penalty
for
displaying
•2
•5
•5
•123
•$6.2
••$6.2
•3
•3
•6
•4200
•$210
•$203.8
•4
•5
•10
•4700
•$235
•$228.8
•0
Where to spend $10 million?
Alternative 1
Air
50%
Ground
100%
Water
25%
Alternative 2
48%
95%
90%
Alternative 3
5%
10%
100%
I’m soft on crime
Benefit
1 Three Strikes
10%
2 Stricter Enforce 8%
ment
3 Address social
50%
issues
Cost
$50 mill
$25 mill
$55 mill
How much safety?
•Cars?
•Airport security?
•Civil liberty?
Education
•Education
•Not High School
Grad
•Average
Income
•18,22
6
•High School
Graduate
•27,28
0
•Associate
•34,17
7
•4 yr College
Graduate
•Master’s
•Marginal
Income
•51,19
4
•Source: U.S. Census Bureau, Statistical Abstract of the U.S. 2004-2005
•60,44
•9,054
= 50%
•
Education
•Education
•Not High School
Grad
•Average
Income
•18,22
6
•High School
Graduate
•27,28
0
•Associate
•34,17
7
•4 yr College
Graduate
•Master’s
•Marginal
Income
•51,19
4
•Source: U.S. Census Bureau, Statistical Abstract of the U.S. 2004-2005
•60,44
•9,054
= 50%
• 6,897 =
25%
Education
•Education
•Not High School
Grad
•Average
Income
•18,22
6
•High School
Graduate
•27,28
0
•Associate
•34,17
7
•4 yr College
Graduate
•Master’s
•Marginal
Income
•51,19
4
•Source: U.S. Census Bureau, Statistical Abstract of the U.S. 2004-2005
•60,44
•9,054
= 50%
• 6,897 =
25%
•17,017 =
50%
•
Education
•Education
•Not High School
Grad
•Average
Income
•18,22
6
•High School
Graduate
•27,28
0
•Associate
•34,17
7
•4 yr College
Graduate
•Master’s
•Marginal
Income
•51,19
4
•Source: U.S. Census Bureau, Statistical Abstract of the U.S. 2004-2005
•60,44
•9,054
= 50%
• 6,897 =
25%
•17,017 =
50%
• 9,251 =
18%
Education
•Education
•Not High School
Grad
•Average
Income
•18,22
6
•High School
Graduate
•27,28
0
•Associate
•34,17
7
•4 yr College
Graduate
•Master’s
•Marginal
Income
•51,19
4
•Source: U.S. Census Bureau, Statistical Abstract of the U.S. 2004-2005
•60,44
•9,054
= 50%
• 6,897 =
25%
•17,017 =
50%
• 9,251 =
18%
Education
•Education
•Not High School
Grad
•Average
Income
•18,22
6
•High School
Graduate
•27,28
0
•Associate
•34,17
7
•4 yr College
Graduate
•Master’s
•Marginal
Income
•51,19
4
•Source: U.S. Census Bureau, Statistical Abstract of the U.S. 2004-2005
•60,44
•9,054
= 50%
• 6,897 =
25%
•17,017 =
50%
• 9,251 =
18%
How much education and training
is right for you?
•
•
•
•
•
•
High school
High school plus vocational training
Two year college degree
Four year college degree
Etc.
The rule: Continue your education as long as
the marginal benefit of additional education is
greater than the marginal opportunity cost of
additional education.
The problem
• The rule is simple.
• The estimates of marginal benefit and
marginal cost is not.
– The estimates are of future benefits and
costs.
– Most of us are not very good at predicting
the future
•
Sunk Cost
•You got to know when to hold ‘em
•Know when to fold ‘em
•Know when to walk away
•And know when to run
SUNK COSTS vs.
MARGINAL COST
• SUNK COSTS
(backward looking
– irrelevant)
•MARGINAL
COSTS
•(the consequences
of choices lie in the
future - only relevant
costs)
Whiteout!
What is the marginal
benefit of your being
there for the next
three days?
What is the marginal
benefit of the best
alternative?
What should you
do?
No Surf!
What is the marginal
benefit of staying for
the next six hours?
What is the marginal
benefit of the best
alternative?
What should you
do?
A terrible movie
 What is the marginal
benefit of staying
there for the next
two hours?
 What is the marginal
benefit of the best
alternative?
 What should you
do?
A horrible marriage?
 What is the marginal
benefit of staying
with the bum for the
next fifty years?
 What is the marginal
benefit of the best
alternative?
 What should you
do?
Use marginal analysis to
explain why you don’t want to
join the “Clean Plate Club.”
•
•
•
•
Was there any mention of
“sunk costs” in any of these
decisions?
Skiing
Surfing
Watching a movie
Marriage
SUNK COSTS
• You have no control
over sunk costs so they
are not part of the
decision-making
process
SUNK COSTS vs.
MARGINAL COST
•The past is gone; you can do nothing about it. The
present is now. The future is determined by your
decisions now. Consider those things that you can
control, not those that you can’t.
•MARGINAL
COSTS
• SUNK COSTS
(backward looking
•(the consequences
– irrelevant)
of choices lie in the
future - only relevant
costs)
Marginal Analysis is Forward
Looking; Sunk Costs are
Irrelevant.
• I paid for this ticket, I’m going to sit here
whether I enjoy it or not.
• I have to fix the transmission; I just bought
$500 worth of tires.
• I have to stay with my husband; I’ve put 23
years into this marriage.
• I paid for this dessert; I have to eat it all.
• Even though this school is built on top of a
contaminated site, we have to continue
construction; we’ve already put $2 million into
it!
Main Points
• Marginal benefit is the addition to total
benefits from one more unit of an activity.
• Marginal cost is the addition to total cost of
one more unit of an activity.
• Every economic decision has a marginal
benefit and a marginal cost.
• Marginal analysis always identifies the
differences between two alternatives.
Main Points
• Marginal analysis compares the marginal
benefits with the marginal opportunity costs of
two alternatives.
• The marginal principle states that the use of a
resource should be continued if the marginal
benefit of additional use of the resource is
greater than the marginal opportunity cost
and should be discontinued if the opposite is
true. MB greater than MOC, continue; MB
less than MOC, stop.
Main Points
• Estimations of marginal benefits and
marginal opportunity costs are
subjective and difficult.
• Sunk costs are irrelevant. A decision
maker compares the marginal benefit
and marginal opportunity costs of the
best two alternatives.