As you know, I’m writing brief blog posts on these 8 guideposts for economic thinking.
1. The use of scarce resources is costly; trade-offs must always be made.
2. Individuals choose purposefully — they try to get the most from their limited resources.
3. Incentives matter — choice is influenced in a predictable way by changes in incentives.
4. Individuals make decisions at the margin.
5. Although information can help us make better choices, its acquisition is costly.
6. Beware of secondary effects: economic actions often generate indirect as well as direct effects.
7. The value of a good or service is subjective.
8. The test of a theory is its ability to predict.
The word margin is used in a variety of ways and in different words. One might have heard the term “marginal tax rates.” Pretty much anyone knows where the margin of a paper is, but what is “the margin” and how and why are decisions made there?
In this instance “Margin” is used to describe the effects a change in a situation, as it is currently understood, makes.
You get stuck at BWI late at night. You need to get to Union Station. You can take a cab, or you can take Super Shuttle. When given at least two alternatives, you weigh the costs and the benefits between the two.
This morning I stopped for breakfast at Bojangles. I started ordering my favorite item there, which is the cajun filet on a biscuit with cheese and a drink. I figured I would make this my lunch, and before I ordered the delicious seasoned fries I backtracked. I ordered a combo.
Why did I do this? Because a combo provided me a better deal than if I had ordered all three items separately. Similarly, pay close attention to the nugget prices at McDonald’s. You can get 4 nuggets for $1. However, a six pack is more expensive than if you ordered two four piece nuggets. Sometimes people don’t pay attention the margins and pay more than they should.
Nobody is perfect at marginal decision making, but most people do it everyday without realizing it. And people value different things. Like my BWI example, some people are willing to pay more not to deal with strangers and long waits. Others value saving money more than they do riding alone or like talking with other people.
It is also present daily in the countless decisions made at your place of work and in your daily life. Marginal decision making is focused on making the most appropriate decision surrounding the net pluses or minuses from the current situation.
“Average” and “marginal” are not the same. We all know how averages are calculated, but the marginal decision of making even more new widgets can be (and many times is) lower than the average cost of a unit. Marginal costs are the change in costs/benefits due to a decision.
Similarly, one must not make the mistake of combining total costs/benefits with marginal costs/benefits. They are not the same. Not every decision an individual makes is that of zero sum game, rather, most are made at margins.
i.e. My car died and I need a new car to continue working. The decision at the margin is what kind of car are you going to buy? How much will you spend? What features? This is a marginal decision.
Same with being stranded late at night at BWI. Those are marginal decisions — you have to get home. You can’t stay at the airport forever. That is a zero sum game decision that nobody but Viktor Navorski seems to choose.
Understanding marginal costs and marginal benefits is a key component to understanding basic economic theory. People will also make mistakes in marginal decision making — I almost did that this morning at Bojangles. And that’s OK. The goal is to be aware of it and constantly thinking the costs and benefits through.