Thinking on the margin – Definition and examples — Conceptually
Nội Dung Chính
What does it mean to think on the margin?
Definition and explanation
Thinking on the margin or marginal thinking means considering how much you value an addition of something. You ignore the sunk costs of what’s already going to happen, and weigh up the costs and benefits of adding in something extra (extra work, money, bananas etc.).
Explanation of marginal analysis
If you have no bananas, and your friend kindly gives you theirs, it could be so valuable to you that it might mean the difference between life and death. But if you have a million bananas (a banana-aire?), that gift is worth much less to you (presuming you have a convex utility function for bananas). That extra banana in both cases — even if it were the exact same banana — is a banana on the margin, and its value varies massively between the scenarios.
As a perhaps more realistic example, a charity might be the most effective in the world on average, but if it’s just fundraised a lot, extra (marginal) donations might be going into their less effective programs.
Say you’re thinking about tending to your banana farm (how else do you get a million bananas?), you want to know whether you should work more to produce more bananas. You might have already invested a lot in making your farm more efficient, meaning that extra resources won’t do as much to improve productivity. This is because, in this case, there are diminishing marginal returns to investment (though you can also have increasing returns, like through economies of scale, advantages of being large in scale).
Economic principle: Rational people think at the margin
The third of Mankiw’s four principles of economics, states that ”rational people think at the margin”:
Rational people systematically and purposefully do the best they can to achieve their objectives, given the available opportunities.” Principles of Macroeconomics 6th Ed. at 6
Thinking at the margin examples
Marginal impact of your donations
Slightly less trivially than the worth of bananas, a lot of people donate to charity. But where would donations do the most good?
This, of course, depends on many factors, but one is what my donation will achieve, not what the average donation to that charity achieves. For this reason, charity evaluator GiveWell, determines the room for more funding of its recommended charities.
Fixed & variable costs in business
Another application of marginal thinking is the profitability of software companies — their profits at the margin are often very high. They have a lot of fixed costs (to develop the software in the first place they need to pay a lot of engineers, rent buildings etc.), but it costs the company little to download or use a program from the internet. Because marginal investments don’t yield as much benefits to you as the first few, we should do the the projects with the highest initial returns first, what’s called ‘pick the low-hanging fruit’.
