Marginal Thinking

1. Marginal Thinking “Is it worth it?”

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! When is enough enough?

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 LifePointAverage, when working on your GPA!

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? • Is this the best use of additional resources?

6. 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)

7. 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)

8. 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.

9. 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?

10. 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?

11. Juan or George?

12. 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?

13. Marginal Opportunity CostHershey’s or Hershey’s with Almonds • More chocolate • Almonds • Chocolate • A • C • B

14. Marginal Opportunity Cost • A • C • B

15. Marginal Opportunity Cost • A • C • B

16. 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

17. Marginal benefit – marginal cost Round 1 Round 2 Round 3 Round 4 Round 5 $1.50 • MC • MB $1.00

18. Marginal benefit – marginal cost Round 1 Round 2 Round 3 Round 4 Round 5 $1.50 • MC • MB $1.00

19. Marginal benefit – marginal cost Round 1 Round 2 Round 3 Round 4 Round 5 $1.45 $1.50 • MC • MB $1.00 $1.20

20. Marginal benefit – marginal cost Round 1 Round 2 Round 3 Round 4 Round 5 $1.45 $1.50 $1.35 • MC • MB $1.25 $1.00 $1.20

21. Marginal benefit – marginal cost Round 1 Round 2 Round 3 Round 4 Round 5 $1.45 $1.50 $1.35 $1.32 • MC • MB $1.27 $1.25 $1.00 $1.20

22. Marginal benefit – marginal cost Round 1 Round 2 Round 3 Round 4 Round 5 $1.45 $1.50 $1.35 $1.32 $1.30 • MC • MB $1.29 $1.27 $1.25 $1.00 $1.20

23. Marginal benefit – marginal cost Round 1 Round 2 Round 3 Round 4 Round 5 $1.45 $1.50 $1.35 $1.32 $1.30 • MC • MB $1.29 $1.27 $1.25 $1.00 $1.20

24. How many rounds to play?

25. How many rounds to play?

26. How many rounds to play?

27. 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!

28. The Marginal Principle: Pursue all activities up to the point where: MB = MOC MB = MOC MB = MC MB = MC MB = MC MB = MC MB = MC MB = MC MB = MC MB = MC

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

30. Marginal Analysis in Allocating Society’s Resources

31. 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

32. Where to spend $10 million? Air Ground Water Alternative 1 50% 100% 25% Alternative 2 48% 95% 90% Alternative 3 5% 10% 100%

33. 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

34. How much safety? • Cars? • Airport security? • Civilliberty?

35. Education • Education • Average Income • Marginal Income • Not High School Grad • High School Graduate • Associate • 4 yr College Graduate • Master’s • 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

36. Education • Education • Average Income • Marginal Income • Not High School Grad • High School Graduate • Associate • 4 yr College Graduate • Master’s • 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

37. Education • Education • Average Income • Marginal Income • Not High School Grad • High School Graduate • Associate • 4 yr College Graduate • Master’s • 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

38. Education • Education • Average Income • Marginal Income • Not High School Grad • High School Graduate • Associate • 4 yr College Graduate • Master’s • 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

39. Education • Education • Average Income • Marginal Income • Not High School Grad • High School Graduate • Associate • 4 yr College Graduate • Master’s • 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

40. Education • Education • Average Income • Marginal Income • Not High School Grad • High School Graduate • Associate • 4 yr College Graduate • Master’s • 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

41. 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.

42. 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

43. 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

44. SUNK COSTS vs.MARGINAL COST • MARGINAL COSTS • (the consequences of choices lie in the future - only relevant costs) • SUNK COSTS (backward looking – irrelevant)

45. 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?

46. 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?

47. 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?

48. 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?

49. Use marginal analysis to explain why you don’t want to join the “Clean Plate Club.”

50. Was there any mention of “sunk costs” in any of these decisions? • Skiing • Surfing • Watching a movie • Marriage