Marginal analysis involves making decisions based on small incremental changes in resources rather than analyzing all decisions at once. This allows for optimal choices given preferences, constraints, and information. While people may not consciously think this way, their actual decisions are as if they do use marginal analysis. The example shows someone deciding how many hours to work based on comparing the marginal benefit of hourly wages to the marginal cost of the opportunity cost of their time. They will work hours where the marginal benefit exceeds the marginal cost, stopping when working the next hour would yield a marginal cost greater than the marginal benefit. Based on the numbers given, marginal analysis suggests working 10 hours is the rational choice.

1. Wednesday, November 23, 2011
Marginal Analysis
Thinking at the Margin
From an economist's perspective, making choices The hourly wage represents what I earn for
involves making decisions 'at the margin' - that is, working an extra hour - it is the marginal gain or
making decisions based on small changes in the marginal benefit.
resources:
How should I spend the next hour? The value of time is essentially an opportunity
cost - it is how much I value having that hour off.
How should I spend the next dollar?
In this example it represents a marginal cost -
On the surface, this seems like a strange way of what it costs me by working an additional hour.
considering the choices made by people and firms. The increase in marginal costs is a common
It is rare that someone would consciously ask phenomenon; I do not mind working a few hours
themselves - 'How will I spend dollar number
since there are 24 hours in a day. I still have
24,387?', 'How will I spend dollar number
24,388?'. Treating the problem in this matter does plenty of time to do other things. However, as I
have some distinct advantages: start to work more hours it reduces the number of
hours I have for other activities. I have to start
Doing so leads to the optimal decisions giving up more and more valuable opportunities to
being made, subject to preferences,
work those extra hours.
resources and informational constraints.
It makes the problem less messy from an
analytic point of view, as we are not trying It is clear that I should work the first hour, as I
to analyze a million decisions at once. gain $10 in marginal benefits and lose only $2 in
marginal costs, for a net gain of $8.
While this does not exactly mimic conscious
decision making processes, it does provide
results similar to the decisions people By the same logic I should work the second and
actually make. That is, people may not think
third hours as well. I will want to work until
using this method, but the decisions they
make are as if they do. which time the marginal cost exceeds the marginal
benefit. I will want to work the 10th hour as I
Marginal Analysis - An Example receive a net benefit of #3 (marginal benefit of
$15, marginal cost of $12). However, I will not
Consider the decision on how many hours to
want to work the 11th hour, as the marginal cost
work, as given by the following chart:
($18) exceeds the marginal benefit ($15) by three
Hour Hourly Wage Value of Time dollars.
Hour 1 $10 $2
Hour 2 $10 $2 Thus marginal analysis suggests that rational
Hour 3 $10 $3 maximizing behavior is to work for 10 hours.
Hour 4 $10 $3
Hour 5 $10 $4
Hour 6 $10 $5
Hour 7 $10 $6
Hour 8 $10 $8
Hour 9 $15 $9
Hour 10 $15 $12
Hour 11 $15 $18
Hour 12 $15 $20