Unit 4: The Margin   03/13/13
The Margin                Is it worth it?                A thing worth doing may not be               worth doing well.   ...
MARGINAL                     Additional, difference                     What is the marginal benefit between a            ...
Unfortunate consequences of        scarcity             You will never be the best parent you could             be.       ...
Using Marginal Benefit/        Marginal Cost Analysis             Investigating two alternatives             What’s the di...
Four realistic questions             How good a parent will you be?             How good a student will you be?           ...
Marginal                      A little more or a little less.                     Compare benefits and cost of            ...
Cleaning the brown lake             The lake is dirty.             Let’s clean it.             How clean?             What...
The relevant questions             If I put one more hour of human capital             into studying,              – what ...
Juan or George?Unit 4: The Margin   03/13/13   1
Marginal Analysis –What’s the        difference?               Marginal is the change the results from a little           ...
Marginal Opportunity Cost    Hershey’s or Hershey’s with Almonds                                       More               ...
Marginal Opportunity Cost                     A   C          BUnit 4: The Margin       03/13/13       1
Marginal Opportunity Cost                     A   C          BUnit 4: The Margin       03/13/13       1
The Marginal Principle             How far should I pursue any single             activity, knowing that the resources I  ...
Marginal benefit – marginal cost  Round 1     Round 2   Round 3 Round 4   Round 5      $1.50                              ...
Marginal benefit – marginal cost  Round 1     Round 2   Round 3 Round 4   Round 5      $1.50              $1.4            ...
Marginal benefit – marginal cost  Round 1     Round 2   Round 3 Round 4   Round 5      $1.50              $1.4            ...
Marginal benefit – marginal cost  Round 1     Round 2   Round 3 Round 4   Round 5      $1.50              $1.4            ...
Marginal benefit – marginal cost  Round 1     Round 2   Round 3 Round 4   Round 5      $1.50              $1.4            ...
Marginal benefit – marginal cost  Round 1     Round 2   Round 3 Round 4   Round 5      $1.50              $1.4            ...
How many rounds to play?        Round           1       2         3        4       5       6        Marginal       $1.50  ...
How many rounds to play?        Round           1       2         3        4       5       6        Marginal       $1.50  ...
How many rounds to play?        Round           1       2         3        4       5       6        Marginal       $1.50  ...
How much of a particular     activity? Know when to move on.             Pursue activities as long as the marginal        ...
The Marginal Principle: Pursue        all activities up to the point        where:Unit 4: The Margin   03/13/13            2
Marginal Principle             MB greater than MOC, go for             it!             MB less than MOC, go back;         ...
Marginal Analysis in       Allocating Society’s ResourcesUnit 4: The Margin   03/13/13           2
Marginal Value of Penalties        (1)             (2)         (3)          (4)        (5)       (6)    Alternative       ...
Where to spend $10 million?                      Air           Ground Water        Alternative 1 50%           100%   25% ...
I’m soft on crime                       Benefit          Cost        1 Three Strikes       10%       $50 mill        2 Str...
How much safety?              Cars?              Airport security?              Civil liberty?Unit 4: The Margin   03/13/1...
Education        Education                                 Average Income Marginal Income         Not High School Grad    ...
Education        Education                                 Average Income Marginal Income         Not High School Grad    ...
Education        Education                                 Average Income Marginal Income         Not High School Grad    ...
Education        Education                                 Average Income Marginal Income         Not High School Grad    ...
Education        Education                                 Average Income Marginal Income         Not High School Grad    ...
Education        Education                                 Average Income Marginal Income         Not High School Grad    ...
How much education and training is        right for you?             High school             High school plus vocational t...
The problem             The rule is simple.             The estimates of marginal benefit and             marginal cost is...
Sunk Cost            You got to know when to hold ‘em            Know when to fold ‘em            Know when to walk away  ...
SUNK COSTS vs.        MARGINAL COST                                          MARGINAL COSTS          SUNK COSTS           ...
Whiteout!                                   What is the                                   marginal benefit of             ...
No Surf!             What is the             marginal benefit of             staying for the next             six hours?  ...
A terrible movie             What is the             marginal benefit of             staying there for the             nex...
A horrible marriage?            What is the             marginal benefit of             staying with the             bum ...
Use marginal analysis to explain       why you don’t want to join the       “Clean Plate Club.”Unit 4: The Margin   03/13/...
Was there any mention of “sunk        costs” in any of these decisions?             Skiing             Surfing            ...
SUNK COSTS             You have no control over             sunk costs so they are not             part of the decision-ma...
SUNK COSTS vs.        MARGINAL COST       The past is gone; you can do nothing about it. The present is now.       The fut...
Unit 4: The Margin   03/13/13   5
Marginal Analysis is Forward             Looking; Sunk Costs are Irrelevant.             I paid for this ticket, I’m going...
Main Points             Marginal benefit is the addition to total             benefits from one more unit of an activity. ...
Main Points             Marginal analysis compares the marginal             benefits with the marginal opportunity costs  ...
Main Points             Estimations of marginal benefits and             marginal opportunity costs are             subjec...
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Mpp#004+marginal.analysis.(55)

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Mpp#004+marginal.analysis.(55)

  1. 1. Unit 4: The Margin 03/13/13
  2. 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. 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. 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. 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. 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. 7. Marginal A little more or a little less. Compare benefits and cost of two alternativesUnit 4: The Margin 03/13/13
  8. 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. 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
  10. 10. Juan or George?Unit 4: The Margin 03/13/13 1
  11. 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. 12. Marginal Opportunity Cost Hershey’s or Hershey’s with Almonds More Almonds chocolate Chocolate A C BUnit 4: The Margin 03/13/13 1
  13. 13. Marginal Opportunity Cost A C BUnit 4: The Margin 03/13/13 1
  14. 14. Marginal Opportunity Cost A C BUnit 4: The Margin 03/13/13 1
  15. 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? IfUnit 4: The Margin 03/13/13 1
  16. 16. Marginal benefit – marginal cost Round 1 Round 2 Round 3 Round 4 Round 5 $1.50 MC MB $1.00Marginal Cost to play each round
  17. 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 0Marginal Cost to play each round
  18. 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 0Marginal Cost to play each round
  19. 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 0Marginal Cost to play each round
  20. 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 0Marginal Cost to play each round
  21. 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 0Marginal Cost to play each round
  22. 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 $.50Unit 4: The Margin 03/13/13 2
  23. 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 $.75Unit 4: The Margin 03/13/13 2
  24. 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 $.81Unit 4: The Margin 03/13/13 2
  25. 25. How much of a particular activity? Know when to move on. Pursue activities as long as the marginal benefit exceeds the marginal opportunity cost. Pursue activities up to the point where MB = MOC If the marginal benefit of another unit of the activity is greater than the marginal opportunity cost, go for it! If the marginal benefit of another unit of the activity is less than the marginal opportunity cost, stop! 03/13/13 2Unit 4: The Margin
  26. 26. The Marginal Principle: Pursue all activities up to the point where:Unit 4: The Margin 03/13/13 2
  27. 27. Marginal Principle MB greater than MOC, go for it! MB less than MOC, go back; you have gone too far.Unit 4: The Margin 03/13/13 2
  28. 28. Marginal Analysis in Allocating Society’s ResourcesUnit 4: The Margin 03/13/13 2
  29. 29. Marginal Value of Penalties (1) (2) (3) (4) (5) (6) Alternative Penalty Penalty New Total Marginal for for beds Cost Cost carrying displaying needed ($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 $228.8Unit 4: The Margin 03/13/13 2
  30. 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. 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 issuesUnit 4: The Margin 03/13/13 3
  32. 32. How much safety? Cars? Airport security? Civil liberty?Unit 4: The Margin 03/13/13 3
  33. 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. 2004-2005Unit 4: The Margin 03/13/13 3
  34. 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. 2004-2005Unit 4: The Margin 03/13/13 3
  35. 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. 2004-2005Unit 4: The Margin 03/13/13 3
  36. 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. 2004-2005Unit 4: The Margin 03/13/13 3
  37. 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. 2004-2005Unit 4: The Margin 03/13/13 3
  38. 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. 2004-2005Unit 4: The Margin 03/13/13 3
  39. 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. 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 futureUnit 4: The Margin 03/13/13 4
  41. 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 runUnit 4: The Margin 03/13/13 4
  42. 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. 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. 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. 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. 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. 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. 48. Was there any mention of “sunk costs” in any of these decisions? Skiing Surfing Watching a movie MarriageUnit 4: The Margin 03/13/13 4
  49. 49. SUNK COSTS You have no control over sunk costs so they are not part of the decision-making processUnit 4: The Margin 03/13/13 4
  50. 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
  51. 51. Unit 4: The Margin 03/13/13 5
  52. 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. 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. 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. 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

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