Margins and Thinking at the Margin

Introduction

What does it mean to think at the margin? It means to think about your next step forward. The word “marginal” means “additional.” The first glass of lemonade on a hot day quenches your thirst, but the next glass, maybe not so much. If you think at the margin, you are thinking about what the next or additional action means for you.

How many additional tomatoes can you get by taking better care of your garden? If an hour extra work weeding means you will get 12 more tomatoes, then one additional hour of work results in 12 additional tomatoes. Economists sometimes summarize that by saying your marginal product of labor is 12. That just means you can get 12 more tomatoes for one additional hour of work.

On the flip side of that, you could equally well say that the marginal cost of a producing one additional tomato is 5 additional minutes (1/12th of an hour) of your labor. Every new tomato costs you another five minutes of weeding. As another example, if one additional Facebook friend costs you an additional 10 minutes of attention, then the marginal cost is 10 minutes of your time per new Facebook friend.

A bus that is half-empty can take on more riders with zero or very little extra cost–perhaps just a few cents more for wear and tear and the cost of gas to haul an extra 150 pounds. Economists would say the marginal cost of an additional rider is nearly zero. But, if buses are always running packed with lines left standing, then the marginal cost of additional riders would be the entire cost of adding another bus. It is very common to have to compare different marginal costs for different scenarios in order to decide which alternative to pursue.

When you drive around the block to park your car for a concert or event, you can keep driving around the block waiting for that perfect, free, on-street parking spot to come available. Or, you can weigh the alternative of spending $10 for a paid parking lot spot. What matters is what you do in the next minute, ten minutes, hour, or day. The marginal cost of finding a parking space could be only $10; or it could be another hour of driving around hoping for a free spot to open up just as you are in position to grab it. If you already spent an hour searching for a great parking spot, you may well do better to let that memory go. Thinking at the margin means to let the past go and to think forward to the next hour, day, year, or dollar that you expend in time or money. What’s better for you now or in the next few minutes? If you think at the margin, you are thinking ahead. At some point, if you continue to drive around the block again and again with no results, an economist would encourage you to think about the future instead of bulleting on the past. You can’t change the past, but you can change what you do next. (Economists sometimes summarize this by saying, “Sunk costs are sunk.”) And in what you do next, you should weigh the costs and benefits starting afresh for the next few minutes of your time–which is what economists mean when they say, “Think at the margin.” At the margin, you could get a parking spot for $10 or you could drive around and maybe get a parking spot for free with a probability of, say, 20% in the next hour. Thinking at the margin means weighing those future options, and not focusing on what you did in the previous hour of frustrating circling around.

The marginal cost of producing computer chips is the entire cost of producing one more computer chip. Producing only one more from your existing equipment and workers may entail only a small cost that is only an additional few pennies per chip. But if you are already maxing out your production, producing even one more may entail producing a hundred thousand more. Which in turn may entail building a new factory and hiring all its workers, or even researching a whole new way to produce chips–perhaps an additional hundred thousand dollars, at an average cost of a dollar per additional chip or even an additional few million dollars. You have to consider all the additional costs for each option before making a decision. Maybe to get just one more chip you still have to pay extra to hire an extra worker to work the night shift, plus hire someone to stand by to do a little more machine maintenance. Maybe paying more overtime for even one more worker will mean paying higher taxes or insurance fees, or will entail more explanations to other workers about why you can’t offer full opportunities for the extra opportunities to everyone. The sum of all those additional costs–from wages to insurance to taxes to emotional burdens and effects on morale–to produce one more computer chip is what economists mean by the marginal cost of a computer chip. You can’t add apples to oranges, so you may have to weigh the various costs in different dimensions. See Real, Relative, and Nominal Prices and What is Economics?

On a hot day, that first blast of cold air as you step into an air conditioned store gives you a tremendous boost. Each succeeding few minutes, though, may give you less pleasure. Economists say your marginal pleasure or marginal utility–your marginal benefit–diminishes as you experience more.

The word “marginal” in common speech or layman’s use sometimes refers to an iffy project. For example, suppose you make sneakers and you have a company division that makes gold-colored sneakers with specialty soles and that division has turned out not to be the big money-maker you hoped. Or maybe that division is breaking even but would be the first division you would cut unless it starts to show more signs of promise. You might refer to that division as being marginal. That usage of the word “marginal” is not what economists mean by the term, although you might be able to see how they are related. The layman’s usage means at the edge or borderline workable.

The term “marginal cost” is not the same as opportunity cost. Opportunity cost is from the perspective of a buyer, while marginal cost is from the perspective of a seller or producer. That is, opportunity cost refers to what you have to sacrifice–at the margin–as a buyer because when you buy one thing you can’t buy something else. Marginal cost refers to what a seller or producer has to sacrifice in order to sell or produce one more item.

If you enjoy math, you might find it helpful to see that in economics the word “marginal” means the derivative or slope of a curve. It’s the additional cost or benefit that derives from a very small change. For example, if you increase your saving by $1, what would be the marginal benefit? It would be some small number–say, an additional 5 cents in interest you might gain, plus some psychological marginal benefit–say, something you value at 2 cents–in terms of additional feelings of security. The marginal benefit would thus be the sum of the 5 cents in interest plus the 2 cents in feelings of additional security, or $0.07 per additional dollar saved. If you plot a curve between the benefits and costs, the slope is .07. That’s the marginal benefit. The marginal cost is the inverse.

Definitions and Basics

Marginalism, from the Concise Encyclopedia of Economics

Adam Smith struggled with what came to be called the paradox of “value in use” versus “value in exchange.” Water is necessary to existence and of enormous value in use; diamonds are frivolous and clearly not essential. But the price of diamonds–their value in exchange–is far higher than that of water. What perplexed Smith is now rationally explained in the first chapters of every college freshman’s introductory economics text. Smith had failed to distinguish between “total” utility and “marginal” utility. The elaboration of this insight transformed economics in the late nineteenth century, and the fruits of the marginalist revolution continue to set the basic framework for contemporary microeconomics.

Marginal Thinking and the Sunk Cost Fallacy, a Marginal Revolution University video.

Thinking on the margin is one of the most fundamental concepts in economics–and a valuable everyday tool for making optimal decisions. For such an important idea, the meaning of marginal thinking is surprisingly simple: when faced with a decision, you should compare the marginal benefit of a possible action to its marginal cost. If the marginal benefit is greater than the marginal cost, do it! Marginal thinking is best illustrated by some examples of everyday decisions. The volume you choose when you watch TV, the pricing strategy of a clothing shop, or even the decision to walk out of a boring film are all informed by marginal thinking. The “Sunk Cost Fallacy” is a common failure to apply marginal thinking. Focusing on past decisions–the price we paid for an item, the time we’ve already invested in a relationship–can lead us astray. We can’t change the past, so only the potential marginal benefit and marginal cost of the next possible action are relevant to decision-making.

The Marginal Revolution

Neoclassical Economics, from the Concise Encyclopedia of Economics.

Several economists in different places at about the same time (the 1870s and 1880s) began to base value on the relationship between costs of production and “subjective elements,” later called “supply” and “demand.” This came to be known as the Marginal Revolution in economics, and the overarching theory that developed from these ideas came to be called neoclassical economics. (The first to use the term “neoclassical economics” seems to have been the American economist Thorstein Veblen.)…

William Stanley Jevons, biography in the Concise Encyclopedia of Economics.

William Jevons was one of three men to simultaneously advance the so-called marginal revolution. Working in complete independence of one another–Jevons in Manchester, England; Leon Walras in Lausanne, Switzerland; and Carl Menger in Vienna–each scholar developed the theory of marginal utility to understand and explain consumer behavior. The theory held that the utility (value) of each additional unit of a commodity–the marginal utility–is less and less to the consumer. When you are thirsty, for example, you get great utility from a glass of water. Once your thirst is quenched, the second and third glasses are less and less appealing. Feeling waterlogged, you will eventually refuse water altogether. “Value,” said Jevons, “depends entirely upon utility.”

In the News and Examples

Costs and Benefits of going to the dentist

The Marginal Tooth, by Bryan Caplan on EconLog

Every patient gets the same lecture: “If you don’t floss, you’ll loose your teeth. I told you this last time, and you’re still not flossing!” Has it ever occurred to dentists that the marginal benefit of flossing may be less than its marginal cost?…

De Minimis, by Allen R. Sanderson.

Here the “plant and planet advocates” are not entirely consistent. If I wanted to minimize the explicit costs of my eggs, I want the chickens cooped-up in cages on large-scale “egg farms.” Eggs laid by free-range chickens are more costly because production is far less efficient. But those who advocate free-range and organic produce are trading off costs against other values–such as my chickens having a little elbow room and a chance to smell some roses. Why do chickens get to have fun but people don’t? We could, I suppose, have more costly free-range lettuce if we just let wind power turbines scatter the seeds instead of planting them in tidy, efficient rows.

Recycling is appealing because it seems to offer a way to simultaneously reduce the amount of waste disposed in landfills and to save natural resources….

A Little History

Carl Menger, biography in the Concise Encyclopedia of Economics.

Carl Menger has the twin distinctions of being the founder of Austrian economics and a cofounder of the marginal utility revolution. Menger worked separately from William Jevons and Leon Walras and reached similar conclusions by a different method. Unlike Jevons, Menger did not believe that goods provide “utils,” or units of utility. Rather, he wrote, goods are valuable because they serve various uses whose importance differs. For example, the first pails of water are used to satisfy the most important uses, and successive pails are used for less and less important purposes.

Leon Walras, biography in the Concise Encyclopedia of Economics.

Separately but almost simultaneously with William Stanley Jevons and Carl Menger, French economist Leon Walras developed the idea of marginal utility and is thus considered one of the founders of the “marginal revolution.”

Advanced Resources

From The Distribution of Wealth: A Theory of Wages, Interest and Profits, by John Bates Clark

We not only admit, but positively claim, that there is a marginal region where wages are adjusted. It furnishes a large outlet for labor; and what men are able to get in this larger marginal field sets the standard of wages. This field is to labor what, in practical thought, the European market is to wheat: it is a place in which any possible surplus of labor may be disposed of at some living rate. If we find such a market, we definitely solve the problem of the law of wages…. [par. VII.26]

Here, then, is a marginal fraction of the supply of labor; and it would seem that it is in a position to set the market rate of pay for all labor. Here, also, is a direct connection between the pay of this marginal part of the laboring force and the product that can be specifically attributed to it. Does this product of marginal labor set the standard of wages, as the price of a final increment sets the general standard of value of commodities? If so, the law of wages would stand thus: (1) By a common mercantile rule, all men of a given degree of ability must take what marginal men of that same ability get. This principle fixes the market rate of wages. (2) Marginal men get what they produce. This principle governs wages more remotely, by fixing a natural standard for them. In this formula we are, indeed, near to the law that we are seeking; but we have not yet reached it. The true law, when accurately stated, sounds much like the foregoing one; but between the two there is a vital difference. [par. VII.29]

In that static condition in which competition would produce its full effects and bring wages to a natural standard, the pay of labor, as has just been shown, would equal the product that could be separately traced to it. We have discovered a limited field in which whatever is produced is due to labor only; but we need to find one that is larger and more elastic. We have to look for an economic field to which many men may go, and in which they will be virtually rent-free and interest-free. They must be able to work unaided and also untaxed and to create a distinguishable product, all of which they will then get. A few men may, of course, till worthless land, and so make themselves free from landlords’ and capitalists’ claims. Many more may utilize instruments of other kinds that are too poor to afford a rent to their owners. A larger number still may get employment as additional workers in establishments that have good working appliances, and that pay no more for the use of them in consequence of the presence of the marginal men…. [par. VIII.1]

It does not follow that, because a man desires that the product of his industry shall not pay tribute to employers, he needs to take himself away from them. Working near to the man who tills a waste piece of land in an independent way, there may be another man who works on similar land for the owner of it, and gets as wages the value of what he raises. This man is as free from a master’s exactions as is the squatter. A man may have, as Adam Smith has said, “neither landlord nor master to share with him,” though he work for a master. If he gives his employer no more in value than his employer gives to him, his product is intact, and it all comes to him as wages. It is in positions like these that most marginal laborers are found. They are not working in solitude, yet their products are distinguishable from all other products…. [par. VIII.2]

Chapter 1. Introduction, by James Buchanan and Gordon Tullock in The Calculus of Consent

The attainment of consent is a costly process, however, and a recognition of this simple fact points directly toward an “economic” theory of constitutions. The individual will find it advantageous to agree in advance to certain rules (which he knows may work occasionally to his own disadvantage) when the benefits are expected to exceed the costs. The “economic” theory that may be constructed out of an analysis of individual choice provides an explanation for the emergence of a political constitution from the discussion process conducted by free individuals attempting to formulate generally acceptable rules in their own long-term interest. It is to be emphasized that, in this constitutional discussion, the prospective utility of the individual participant must be more broadly conceived than in the collective-choice process that takes place within defined rules. [par. 3.1.12]