THE MARGIN

1
Marginal Thinking
2
The Margin

• Is it worth it?
• A thing worth doing may not be worth doing well.
• Know when its time to move on!
• Look forward, not back!

3
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.

4
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 LPA, not your GPA!

5
Using Marginal Benefit/Marginal Cost Analysis

• Investigating two alternatives
• Whats the difference in benefits between the
  two?
• Whats the difference in opportunity cost between
  the two?
• Is the marginal benefit of the choice greater
  than the marginal opportunity cost?

6
Four realistic questions

• How good a parent will you be?
• How good a student will you be?
• How good a spouse will you be?
• How good a teacher will I be?

7
Marginal

• A little more or a little less. Compare benefits
  and cost of
• two alternatives

8
Cleaning the brown lake

• The lake is dirty.
• Lets clean it.
• How clean?
• What are the benefits of different degrees of
  clean?
• What is the marginal opportunity cost?

9
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?

10
Juan or George?
11
Marginal Analysis Whats 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?

12
Marginal Opportunity CostHersheys or Hersheys
with Almonds
More chocolate
Almonds
Chocolate
A
B
C
13
Marginal Opportunity Cost
A
B
C
14
Marginal Opportunity Cost
A
B
C
15
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

16
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
17
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
18
Marginal benefit marginal cost
Round 1
Round 2
Round 3
Round 4
Round 5
1.50
1.45
1.35
MC
MB
1.25
1.20
1.00
Marginal Cost to play each round
19
Marginal benefit marginal cost
Round 1
Round 2
Round 3
Round 4
Round 5
1.50
1.45
1.35
1.32
MC
MB
1.27
1.25
1.20
1.00
Marginal Cost to play each round
20
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
1.29
1.27
1.25
1.20
1.00
Marginal Cost to play each round
21
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
1.29
1.27
1.25
1.20
1.00
Marginal Cost to play each round
22
How many rounds to play?
23
How many rounds to play?
24
How many rounds to play?
25
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!

26
The Marginal Principle Pursue all activities up
to the point where
MB MOC
MB MC
MB MOC
MB MC
MB MC
MB MC
MB MC
MB MC
MB MC
MB MC
27
Marginal Principle

• MB greater than MOC, go for it!
• MB less than MOC, go back you have gone too far.

28
Marginal Analysis in Allocating Societys
Resources
29
Marginal Value of Penalties
(1) Alternative
(6) Marginal Cost (mil)
(2) Penalty for carrying
(3) Penalty for displaying
(4) New beds needed
(5) Total Cost (mil)
1
0
0
0
--
0
2
5
5
123
6.2
6.2
3
6
4200
210
203.8
3
228.8
5
10
4700
235
4
30
Where to spend 10 million?

• Air Ground Water
• Alternative 1 50 100 25
• Alternative 2 48 95 90
• Alternative 3 5 10 100

31
Im soft on crime

• Benefit Cost
• 1 Three Strikes 10 50 mill
• 2 Stricter Enforce 8 25 mill
• ment
• 3 Address social 50 55 mill
• issues

32
How much safety?

• Cars?
• Airport security?
• Civil liberty?

33
Education
Education
Average Income
Marginal Income
Not High School Grad High School
Graduate Associate 4 yr College
Graduate Masters Doctorate Professional
18,226 27,280 34,177 51,194 60,445 89,734 112,845
9,054 50
Source U.S. Census Bureau, Statistical Abstract
of the U.S. 2004-2005
34
Education
Education
Average Income
Marginal Income
Not High School Grad High School
Graduate Associate 4 yr College
Graduate Masters Doctorate Professional
18,226 27,280 34,177 51,194 60,445 89,734 112,845
9,054 50 6,897 25
Source U.S. Census Bureau, Statistical Abstract
of the U.S. 2004-2005
35
Education
Education
Average Income
Marginal Income
Not High School Grad High School
Graduate Associate 4 yr College
Graduate Masters Doctorate Professional
18,226 27,280 34,177 51,194 60,445 89,734 112,845
9,054 50 6,897 25 17,017 50
Source U.S. Census Bureau, Statistical Abstract
of the U.S. 2004-2005
36
Education
Education
Average Income
Marginal Income
Not High School Grad High School
Graduate Associate 4 yr College
Graduate Masters Doctorate Professional
18,226 27,280 34,177 51,194 60,445 89,734 112,845
9,054 50 6,897 25 17,017 50 9,251
18
Source U.S. Census Bureau, Statistical Abstract
of the U.S. 2004-2005
37
Education
Education
Average Income
Marginal Income
Not High School Grad High School
Graduate Associate 4 yr College
Graduate Masters Doctorate Professional
18,226 27,280 34,177 51,194 60,445 89,734 112,845
9,054 50 6,897 25 17,017 50 9,251
18 29,289 48
Source U.S. Census Bureau, Statistical Abstract
of the U.S. 2004-2005
38
Education
Education
Average Income
Marginal Income
Not High School Grad High School
Graduate Associate 4 yr College
Graduate Masters Doctorate Professional
18,226 27,280 34,177 51,194 60,445 89,734 112,845
9,054 50 6,897 25 17,017 50 9,251
18 29,289 48 23,111 26
Source U.S. Census Bureau, Statistical Abstract
of the U.S. 2004-2005
39
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.

40
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

41
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
42
SUNK COSTS vs.MARGINAL COST
MARGINAL COSTS (the consequences of choices lie
in the future - only relevant costs)
SUNK COSTS (backward looking irrelevant)
43
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?

44
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?

45
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?

46
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?

47
Use marginal analysis to explain why you dont
want to join the Clean Plate Club.
48
Was there any mention of sunk costs in any of
these decisions?

• Skiing
• Surfing
• Watching a movie
• Marriage

49
SUNK COSTS

• You have no control over sunk costs so they are
  not part of the decision-making process

50
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 cant.
MARGINAL COSTS (the consequences of choices lie
in the future - only relevant costs)
SUNK COSTS (backward looking irrelevant)
51
History is Irrelevant .... in terms of costs.
Sunk costs should have no impact on your
decisions.
52
Marginal Analysis is Forward Looking Sunk Costs
are Irrelevant.

• I paid for this ticket, Im 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 Ive 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 weve already put 2 million into
  it!

53
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.

54
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.

55
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.