Reading: Lesson 2 – Thinking at the Margin

Lesson 2 – Thinking at the Margin

 

Description:

When making a decision, we don’t typically have to choose between all or none. We typically weigh the costs and benefits of acquiring one additional (or one fewer) unit of a good or service. We usually make our decision about the next increment. This is thinking at the margin.

In this lesson, students will watch a short video introducing the concepts of marginal cost and marginal benefit. Next students watch a video in which Prof. Mario Villarreal-Diaz explains what it means to think at the margin. Students will then read an article that further illustrates the role of marginal thinking in economics. This lesson concludes with an activity which uses marshmallows to illustrate the concept of diminishing marginal utility.

 

Time Required:

45 min

 

Required Materials:

Internet connection, writing instrument, bag of jumbo marshmallows

 

Prerequisites:

Lesson 3.1 - Scarcity, Choice, and Tradeoffs

 

3.2.A – For a simplified explanation of marginal benefit and marginal cost, watch and discuss the following video using the questions below to guide your discussion [5 min]:

Video: (Mikayla Kutsuris, 1:45 min)

This video simply and clearly defines the basic concepts of marginal benefit and marginal cost and illustrates these concepts with examples.

Discussion Questions: Marginal Benefit and Marginal Cost

1.  Explain the concepts of marginal benefit and marginal cost. Highlight some examples of when you have used marginal benefit and marginal cost to make a decision recently about whether or not to purchase an additional good.

a.      The video explains “The marginal benefit is the benefit from each additional increment or unit” and “The marginal cost is the cost from each additional increment or unit.”

b.      Consumers will purchase a good only if the perceived marginal benefit to them is higher than the marginal cost they incur from purchasing the good.

c.      If the marginal cost is higher than the marginal benefit the consumer will not purchase the good and put their resources towards something of higher value.

d.      Examples may including deciding whether or not to buy an additional slice of pizza, an additional magazine for a trip, or an additional pair of jeans when shopping, etc.

 

3.2.B – Watch and discuss the following video using the questions below to guide your discussion [10 min]:

Video: by Mario Villarreal-Diaz (Learn Liberty, 4:31 min)

“Why are diamonds more expensive than water? Prof. Mario Villarreal-Diaz answers this question using what economists call marginal analysis. Essentially, the marginal utility of water decreases faster than the marginal utility of diamonds. Put another way, people face decisions in a particular context and time. In modern economies, people have ready access to water on the margin, but do not have the same level of access to diamonds.”

Discussion Questions: Thinking on the Margin

1.  What does it mean to “make a decision at the margin?”

a.      Thinking at the margin means thinking about the next increment or the next unit.

b.      Making decisions involves making comparisons between choices in a specific context and at a specific time.

c.      As explained in the  “Choices and tradeoffs are based on comparisons – when trying to decide ‘What is the best choice?’ depends on those comparisons. One alternative versus another alternative.”

d.      When we make choices, we typically don’t have to choose between all and nothing. For example, we don’t have to choose between all the water in the world and no water at all.

e.      When a person makes a decision at the margin it means he or she is weighing the costs and benefits of acquiring one additional (or one fewer) unit of a good.

f.       Note: When consumers make real life decisions they are not usually choosing between just two goods – they are choosing between many alternatives.

 

2.  Explain the concept of marginal utility. Do you think donuts have increasing or decreasing marginal utility?

a.      Goods with diminishing marginal utilities are goods that provide less utility with each additional unit.

b.      Marginal utility is the additional benefit (utility) that is provided by an additional unit of a good or service.

c.      One example of diminishing marginal utility is when a consumer decides to eat multiple donuts. If the customer is craving donuts, the marginal utility may be quite high for the first donut. After the sixth donut, the marginal utility of eating a seventh donut is likely much lower.

 

3.  How does thinking at the margin help entrepreneurs make better decisions?

a.      When making decisions at the margin, entrepreneurs weigh the costs and benefits of one more or one less. For example, as a business owner you would not choose between hiring zero employees or all the employees in the world.

b.      When making the decision to hire, the entrepreneur compares the marginal cost of one additional employee to the expected marginal benefits that the employee is able to provide.

 

3.2.C – Read and discuss the following article using the questions below to guide your discussion [15 min]:

Article: It’s the Margin that Counts by Dwight Lee (FEE.org)

“Marginalism shows how economic reasoning allows us to accomplish more by accepting limits on what can be accomplished—by focusing on marginal (some will say mundane) adjustments to make things better, rather than on more heroic attempts to solve problems totally and completely.”

Discussion Questions: It’s the Margin that Counts

1.  Use the economic concepts of “scarcity” and “marginal utility” to explain why water is typically less expensive than diamonds and why nurses are typically paid less than professional wrestlers.

a.      Two main economic concepts explain why diamonds are more expensive than water – marginal utility and scarcity.

b.      Under normal conditions, diamonds are a much scarcer resource than water. Although water is essential to life, it is usually readily available. Diamonds do have qualities people enjoy, but they are not essential to life. However, diamonds are not readily available. This is one factor why diamonds are typically more expensive than water.

c.      Water has a diminishing marginal utility - this means the first bottle of water a person drinks when they are thirsty has more value than the second, the second more than the third and so on. Diamonds however, do not have a diminishing marginal utility – the second and third diamond tend to be just as valuable to a person as the first. Additional diamonds usually do not have less value to a person.

 

2.  What is the difference between marginal value and total value?

a.      Dwight Lee explains “Price reflects the value people place on one or more unit of something (its marginal value), not the value of all of it (its total value).”

b.      As discussed in the article with the example of water and diamonds, the total value of a good can be very high but the price low. The author writes “…because water is plentiful (except in unusual circumstances), the amount people are willing to pay for one more gallon is close to zero – the marginal value of water is low. On the other hand, diamonds are so rare that people are willing to pay thousands of dollars for one more.” Price is a reflection of the marginal value of something, not the total value.

 

3.  Using the concepts of marginal value and total value, explain why professional wrestlers are often paid more than nurses.

a.      More people have the necessary skills to become a nurse – the skills for the job can be taught through education, whereas the ability to be a wrestler relies on being born with a certain body type – a trait very few people have. Therefore the supply of potential wrestlers is much scarcer than the supply of nurses.

b.      As Prof Lee explains, “Although the total value of nurses is far greater than the total value of wrestlers, the marginal value of nurses is far less. And it is the marginal value of people in an occupation, not total value, which is important in determining salaries in that occupation.”

 

4.  Should there be a government-mandated minimum wage for employees with a high total value but low marginal value (e.g. nurses)? What would be the consequences of implementing a mandatory minimum wage?

a.      Artificially raising the minimum wage of nurses above market prices for nurses could cause the marginal cost of labor to exceed the marginal benefit provided by the employee. As a result, hospitals & health clinics might then try to operate with fewer nurses to reduce costs. In other word, there would be fewer jobs for nurses.

b.      If wages are artificially increased, more people might enroll into courses to become nurses, however fewer would be able to find jobs. This lead would lead to many qualified nurses in the market without jobs and too few nurses working in hospitals.

 

3.2.D – Complete the following activity and share your ideas with the group [15 min]:

Activity: Diminishing Marshmallow (Marginal) Utility

The purpose of this activity is to illustrate the concept of diminishing marginal utility. Students will see how, at a certain point, the value of eating an additional marshmallow begins to decrease.

Materials:

·        Marshmallows (or donuts or similar food)

·        Whiteboard (or poster board) to record values

Directions:

1.      Ask for three student volunteers to participate in an activity. Seat them at the front of the class. Have another student volunteer to record the values on the board.

2.      Ask the volunteers to rate their desire for a marshmallow on a scale of 0-10

3.      Ask them to eat one marshmallow and then rate their desire for another marshmallow.

4.      Continue to get the volunteers to eat one marshmallow at a time and record their desire for another marshmallow after each marshmallow is eaten.

5.      Quickly, the student’s desire for an additional marshmallow will decrease because they won’t get the same marginal benefit from eating the first marshmallow and eating the 10^th marshmallow.

6.      Ask the students to graph the values from the board.

7.      Hold a class discussion using the questions below.

Discussion Questions:

1.  What is utility? Did the students get the same utility from the first marshmallow as they did from the last marshmallow they ate?

a.      “Utility” refers to the benefit a person experiences from consuming something to satisfy a desire.

b.      It’s unlikely the utility stays the same, because students’ hunger and desire for sugar will change.

c.      Because their hunger/desire for a sweet is reduced early on, and by each marshmallow they eat, the utility—or benefit—of each subsequent marshmallow also typically decreases.

 

2.  What other examples of diminishing marginal utility can you think of?

a.      Multiple bottles of water on a hot day is one example. You might get a lot of value from the first, but after the second or third you probably would not want to keep drinking.

b.      A smart phone is another example. You might highly value a smart phone, perhaps even a second. But the value of the third, fourth, and fifth smart phone you receive would have less utility to you than the first.

 

3.  How can entrepreneurs use “thinking at the margin” to make better decisions?

o   When entrepreneurs are making decisions, they typically don’t have to choose between all or nothing. For example, they may have to decided whether to produce one more unit or hire one more employee.

o   Entrepreneurs can benefit from "thinking at the margin" by understanding and taking into consideration the additional costs and benefits for each additional unit or action to analyze if the decision will be beneficial at the margin.

Lesson Recap

·        The marginal utility is the additional benefit that consumers receive when they consume an additional (or one fewer) unit of a good or service.

 

·        Marginal cost is the cost from each additional increment or unit of a good.

 

·        Goods with diminishing marginal utilities are goods that provide less utility with each additional unit consumed.

 

·        Thinking at the margin means thinking about the next increment or the next unit. We usually don’t have to choose between all or none of a good. When making decisions, we typically weigh the costs and benefits of acquiring one additional (or one fewer) unit of a good or service.

 

·        “One of the most useful economic concepts is marginalism – the effect of incremental, or small, changes. Marginalism shows how economic reasoning allows us to accomplish more by accepting limits on what can be accomplished – by focusing on marginal (some will say mundane) adjustments to make things better, rather than on more heroic attempts to solve problems totally and completely.” – Dwight Lee

 

Additional Resources

Article: In Praise of Athletes' High Salaries by William Anderson (FEE.org)

“The solution to the paradox came from the “marginalists” of the mid and late nineteenth century, including Carl Menger of Austria, William Stanley Jevons of England, and Jules Dupuit of France. Value, they astutely pointed out, is determined by the usefulness of the marginal available unit of the item in question, or marginal utility. An individual imputes value to a particular unit of water, not to the overall characteristics of water itself.

 

Article: Take This Job and Shove It, at the Margin by Dwight R. Lee (FEE.org)

“Economists also recognize that while people generally enjoy their work in total, most jobs are a pain at the margin. Even if you get tremendous satisfaction from your job, the marginal satisfaction can be very low, in fact negative. Well before the work day is over, most of us are tired of the grind and would love to leave work early and do something else. We would like to tell the boss, “Take this job and shove it, at the margin.” People put in eight hours of diligent effort because there is a financial inducement to do so.”

 

Article: Margins and Thinking at the Margin (Library of Economics and Liberty)

“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.”

 

Article: Marginal Analysis – Thinking at the Margin (About Education)

“From an economist’s perspective, making choices involves making decisions ‘at the margin’ – that is, making decisions based on small changes in resources: How should I spend the next hour? How should I spend the next dollar? On the surface, this seems like a strange way of considering the choices made by people and firms…Treating the problem in this matter does have some distinct advantages.”