Marginal Benefit/Marginal
Opportunity Cost
Analysis
Refining Benefit/Cost
Analysis
The Margin
Do you really want to give up
some ____to gain some ______?
Is it worth it?
A thing worth doing may not be
worth doing well.
When is enough too much?
.
MARGINAL
• Large fries and medium coke or large coke
and medium fries? You don’t have enough
money for large coke and large fries.
• You choose the large fries; you give up the
large coke.
• Were the additional fries better than the
larger coke would have been?
MARGINAL
• Sleep 15 minutes longer or get up now and
have 15 minutes more to do your hair, enjoy
your breakfast, read the newspaper, get to
work/school early, or whatever you would do
during those additional 15 minutes.
• What is the marginal benefit of an additional
15 minutes of sleep? What is the marginal
opportunity cost?
• Will the additional sleep be worth the
marginal 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, while working
on your GPA, Parent Point Average, Teacher
Point Average!
Using Marginal Benefit/
Marginal Cost Analysis
• You have limited resources? How should you
use them?
• If you use a resource for more of one activity,
you will do less of another activity.
• In making a choice to use resources, does
the choice provide greater additional benefits
than the alternative you would have chosen?
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 are the marginal opportunity costs
of different degrees of clean?
The relevant questions for a
parent/student
• 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?
Juan or George?
Who to date?
• If you go with George, you gain some
fame, but you give up some comfort.
• Do you really want to give up some
comfort and ease with Juan for some
fame with George?
• Marginal Benefit = some fame; Marginal
Opportunity Cost = some comfort
Marginal Analysis –What’s the
difference?
• Marginal is the change that 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 you
compare two alternatives and are going to do
more of one and less of another or more of
one and not more of another.
• Is the marginal benefit worth what I will be
giving up?
The marginal question
• Do you really want to give up this much
of ________,
• In order to gain this much of ________?
Consumer Decisions
• I Pod – how much memory? What does the
extra memory give me, what would I do with
the extra money if I don’t get the bigger
memory?
• I’m looking at two cars. One is $5000 more
than the other. What does the additional
$5000 get me, what would I do with the
$5000 if I get the less expensive car?
Study Decisions
• Two tests tomorrow, econ and math.
• It’s 5 PM, I have studied two hours for
econ, nothing for math.
• I have four hours left. How should I use
my human capital in those four hours?
More econ and some math, no econ, all
math, some combination.
Resource Decisions
• How much California land for wildlife
preserves; how much for housing?
• How much land for the Spotted Owl;
how much for timber?
• How many resources for Gifted and
Talented programs; how many for Head
Start?
Marginal Opportunity Cost
Hershey’s or Hershey’s with Almonds
If you choose A, you give up some chocolate;
if you choose B, you give up almonds.
More
chocolate
Almonds
A
Chocolate
C
B
Marginal Opportunity Cost
A DIFFICULT DECISION
A
C
B
Marginal Opportunity Cost
AN EASY DECISION
A
C
B
The Marginal Principle
• How far should I pursue any single
activity, knowing that every resource I
use has an opportunity cost; every
resource could be used some other
way?
• If I gain more than I give up (if the MB is
greater than the MOC), I should use
the resource in this activity.
Marginal benefit – marginal
cost
Round 1
Round 2 Round 3 Round 4 Round 5
$1.50
MC
MB
$1.00
Marginal Cost to play each round
Marginal benefit – marginal
cost
Round 1
Round 2 Round 3 Round 4 Round 5
$1.50
$1.45
MC
MB
$1.20
$1.00
Marginal Cost to play each round
Marginal benefit – marginal
cost
Round 1
Round 2 Round 3 Round 4 Round 5
$1.50
$1.45
$1.35
MC
MB
$1.20
$1.25
$1.00
Marginal Cost to play each round
Marginal benefit – marginal
cost
Round 1
Round 2 Round 3 Round 4 Round 5
$1.50
$1.45
$1.35
$1.32
MC
MB
$1.20
$1.25
$1.27
$1.00
Marginal Cost to play each round
Marginal benefit – marginal
cost
Round 1
Round 2 Round 3 Round 4 Round 5
$1.50
$1.45
$1.35
$1.32
$1.30
MC
MB
$1.20
$1.25
$1.27 $1.29
$1.00
Marginal Cost to play each round
Marginal benefit – marginal
cost
Round 1
Round 2 Round 3 Round 4 Round 5
$1.50
$1.45
$1.35
$1.32
$1.30
MC
MB
$1.20
$1.25
$1.27 $1.29
$1.00
Marginal Cost to play each round
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
$.81
How much of a particular
activity? Know when to move on.
• Pursue activities as long as the marginal
benefit exceeds the marginal opportunity
cost.
• Pursue activities as long as:
MB > MOC.
• If the marginal benefit of another unit of the
activity is greater than the marginal
opportunity cost, go for it!
• If the marginal benefit of another unit of the
activity is less than the marginal opportunity
cost, stop!
The Marginal Principle:
Pursue all activities up to the
point where:
Marginal Principle
• MB greater than MOC, go for
it!
• MB less than MOC, go back;
you have gone too far.
Marginal Analysis in
Using Society’s Resources
Marginal Value of Penalties for
carrying and/or displaying guns
(1)
Alternative
(2)
Penalty
for
carrying
(3)
Penalty
for
displaying
(4)
New
beds
needed
(5)
Total
Cost
($mil)
(6)
Marginal
Cost
($mil)
1
0
0
0
0
--
2
5
5
123
$6.2
3
3
6
4200
$210
$203.8
4
5
10
4700
$235
$228.8
$6.1
Where to spend $10 million?
How much to clean?
Alternative 1
Air
50%
Ground
100%
Water
25%
Alternative 2
48%
95%
90%
Alternative 3
5%
10%
100%
I’m soft on crime
1 Three Strikes
2 Stricter Enforce
ment
3 Address social
issues
Marg Ben
Marg Opp Cost
10%
8%
$50 mill
$25 mill
50%
$55 mill
How much safety?
•Cars?
•Airport security?
•Civil liberty?
Education
Education
Average Income Marginal Income
Not High School Grad
18,226
High School Graduate
27,280
Associate
34,177
4 yr College Graduate
51,194
Master’s
60,445
Doctorate
89,734
Professional
112,845
Source: U.S. Census Bureau, Statistical Abstract of the U.S. 2004-2005
9,054 = 50%
Education
Education
Average Income Marginal Income
Not High School Grad
18,226
High School Graduate
27,280
9,054 = 50%
Associate
34,177
6,897 = 25%
4 yr College Graduate
51,194
Master’s
60,445
Doctorate
89,734
Professional
112,845
Source: U.S. Census Bureau, Statistical Abstract of the U.S. 2004-2005
Education
Education
Average Income Marginal Income
Not High School Grad
18,226
High School Graduate
27,280
9,054 = 50%
Associate
34,177
6,897 = 25%
4 yr College Graduate
51,194
17,017 = 50%
Master’s
60,445
Doctorate
89,734
Professional
112,845
Source: U.S. Census Bureau, Statistical Abstract of the U.S. 2004-2005
Education
Education
Average Income Marginal Income
Not High School Grad
18,226
High School Graduate
27,280
9,054 = 50%
Associate
34,177
6,897 = 25%
4 yr College Graduate
51,194
17,017 = 50%
Master’s
60,445
9,251 = 18%
Doctorate
89,734
Professional
112,845
Source: U.S. Census Bureau, Statistical Abstract of the U.S. 2004-2005
Education
Education
Average Income Marginal Income
Not High School Grad
18,226
High School Graduate
27,280
9,054 = 50%
Associate
34,177
6,897 = 25%
4 yr College Graduate
51,194
17,017 = 50%
Master’s
60,445
9,251 = 18%
Doctorate
89,734
29,289 = 48%
Professional
112,845
Source: U.S. Census Bureau, Statistical Abstract of the U.S. 2004-2005
Education
Education
Average Income Marginal Income
Not High School Grad
18,226
High School Graduate
27,280
9,054 = 50%
Associate
34,177
6,897 = 25%
4 yr College Graduate
51,194
17,017 = 50%
Master’s
60,445
9,251 = 18%
Doctorate
89,734
29,289 = 48%
Professional
112,845
23,111 = 26%
Source: U.S. Census Bureau, Statistical Abstract of the U.S. 2004-2005
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 are not.
– The estimates are of future benefits and
costs.
– Most of us are not very good at predicting
the future
– Those who gain and those who pay the
cost are often different.
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
MARGINAL COSTS
SUNK COSTS
(backward looking –
irrelevant)
(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 –
irrelevant)
(the consequences of
choices lie in the future only relevant costs)
Marginal Analysis is Forward
Looking; Sunk Costs are
Irrelevant.
• I paid for this movie; 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.
• This book is awful but I’ve read 150 pages so
I have to finish 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.
• A decision maker compares the future
marginal benefit and future marginal
opportunity costs of the best two future
alternatives. Sunk costs are irrelevant.