2. 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!
Unit 4: The Margin 03/13/13
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.
Unit 4: The Margin 03/13/13
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!
Unit 4: The Margin 03/13/13
5. 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?
Unit 4: The Margin 03/13/13
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?
Unit 4: The Margin 03/13/13
7. Marginal
A little more or a little less.
Compare benefits and cost of
two alternatives
Unit 4: The Margin 03/13/13
8. 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?
Unit 4: The Margin 03/13/13
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?
Unit 4: The Margin 03/13/13
11. 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?
Unit 4: The Margin 03/13/13 1
12. Marginal Opportunity Cost
Hershey’s or Hershey’s with Almonds
More
Almonds chocolate
Chocolate
A C B
Unit 4: The Margin 03/13/13 1
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
Unit 4: The Margin 03/13/13 1
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
$1.4
5
MC
MB
$1.2
$1.00 0
Marginal Cost to play each round
18. Marginal benefit – marginal cost
Round 1 Round 2 Round 3 Round 4 Round 5
$1.50
$1.4
$1.35
5
MC
MB
$1.25
$1.2
$1.00 0
Marginal Cost to play each round
19. Marginal benefit – marginal cost
Round 1 Round 2 Round 3 Round 4 Round 5
$1.50
$1.4
$1.35
5 $1.32
MC
MB
$1.27
$1.25
$1.2
$1.00 0
Marginal Cost to play each round
20. Marginal benefit – marginal cost
Round 1 Round 2 Round 3 Round 4 Round 5
$1.50
$1.4
$1.35
5 $1.32 $1.30
MC
MB
$1.27 $1.29
$1.25
$1.2
$1.00 0
Marginal Cost to play each round
21. Marginal benefit – marginal cost
Round 1 Round 2 Round 3 Round 4 Round 5
$1.50
$1.4
$1.35
5 $1.32 $1.30
MC
MB
$1.27 $1.29
$1.25
$1.2
$1.00 0
Marginal Cost to play each round
22. How many rounds to play?
Round 1 2 3 4 5 6
Marginal $1.50 $1.45 $1.35 $1.32 $1.30 $1.25
Benefit
Marginal $1.00 $1.20 $1.25 $1.27 $1.29 $1.35
Opportunity
Cost
Marginal Net $.50
Gain
Total Gain $.50
Unit 4: The Margin 03/13/13 2
23. How many rounds to play?
Round 1 2 3 4 5 6
Marginal $1.50 $1.45 $1.35 $1.32 $1.30 $1.25
Benefit
Marginal $1.00 $1.20 $1.25 $1.27 $1.29 $1.35
Opportunity
Cost
Marginal Net $.50 $.25
Gain
Total Gain $.50 $.75
Unit 4: The Margin 03/13/13 2
24. How many rounds to play?
Round 1 2 3 4 5 6
Marginal $1.50 $1.45 $1.35 $1.32 $1.30 $1.25
Benefit
Marginal $1.00 $1.20 $1.25 $1.27 $1.29 $1.35
Opportunity
Cost
Marginal Net $.50 $.25 $.10 $.05 $.01 -$.10
Gain
Total Gain $.50 $.75 $.85 $.90 $.91 $.81
Unit 4: The Margin 03/13/13 2
25. How much of a particular
activity? Know when to move on.
Pursue activities as long as the marginal
benefit exceeds the marginal opportunity
cost.
Pursue activities up to the point where
MB = MOC
If the marginal benefit of another unit of the
activity is greater than the marginal
opportunity cost, go for it!
If the marginal benefit of another unit of the
activity is less than the marginal opportunity
cost, stop! 03/13/13 2
Unit 4: The Margin
26. The Marginal Principle: Pursue
all activities up to the point
where:
Unit 4: The Margin 03/13/13 2
27. Marginal Principle
MB greater than MOC, go for
it!
MB less than MOC, go back;
you have gone too far.
Unit 4: The Margin 03/13/13 2
28. Marginal Analysis in
Allocating Society’s Resources
Unit 4: The Margin 03/13/13 2
29. Marginal Value of Penalties
(1) (2) (3) (4) (5) (6)
Alternative Penalty Penalty New Total Marginal
for for beds Cost Cost
carrying displaying needed ($mil) ($mil)
1 0 0 0 0 --
2 5 5 123 $6.2 $6.2
3 3 6 4200 $210 $203.8
4 5 10 4700 $235 $228.8
Unit 4: The Margin 03/13/13 2
30. Where to spend $10 million?
Air Ground Water
Alternative 1 50% 100% 25%
Alternative 2 48% 95% 90%
Alternative 3 5% 10% 100%
Unit 4: The Margin 03/13/13 3
31. I’m 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
Unit 4: The Margin 03/13/13 3
32. How much safety?
Cars?
Airport security?
Civil liberty?
Unit 4: The Margin 03/13/13 3
33. Education
Education Average Income Marginal Income
Not High School Grad 18,226
High School Graduate 27,280 9,054 = 50%
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
Unit 4: The Margin 03/13/13 3
34. 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
Unit 4: The Margin 03/13/13 3
35. 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
Unit 4: The Margin 03/13/13 3
36. 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
Unit 4: The Margin 03/13/13 3
37. 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
Unit 4: The Margin 03/13/13 3
38. 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
Unit 4: The Margin 03/13/13 3
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.
Unit 4: The Margin 03/13/13 3
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
Unit 4: The Margin 03/13/13 4
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
Unit 4: The Margin 03/13/13 4
42. SUNK COSTS vs.
MARGINAL COST
MARGINAL COSTS
SUNK COSTS (the consequences of
(backward looking = choices lie in the future =
irrelevant) only relevant costs)
Unit 4: The Margin 03/13/13 4
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?
Unit 4: The Margin 03/13/13 4
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?
Unit 4: The Margin 03/13/13 4
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?
Unit 4: The Margin 03/13/13 4
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?
Unit 4: The Margin 03/13/13 4
47. Use marginal analysis to explain
why you don’t want to join the
“Clean Plate Club.”
Unit 4: The Margin 03/13/13 4
48. Was there any mention of “sunk
costs” in any of these decisions?
Skiing
Surfing
Watching a movie
Marriage
Unit 4: The Margin 03/13/13 4
49. SUNK COSTS
You have no control over
sunk costs so they are not
part of the decision-making
process
Unit 4: The Margin 03/13/13 4
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 can’t.
MARGINAL COSTS
SUNK COSTS (the consequences of
(backward looking = choices lie in the future
irrelevant) = only relevant costs)
Unit 4: The Margin 03/13/13 5
52. 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!
Unit 4: The Margin 03/13/13 5
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.
Unit 4: The Margin 03/13/13 5
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.
Unit 4: The Margin 03/13/13 5
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.
Unit 4: The Margin 03/13/13 5
