Principle #3: “How Much” Is a Decision at the Margin

Some important decisions involve an “either–or” choice—for example, you decide either to go to college or to begin working; you decide either to take economics or to take something else. But other important decisions involve “how much” choices—for example, if you are taking both economics and chemistry this semester, you must decide how much time to spend studying for each. When it comes to understanding “how much” decisions, economics has an important insight to offer: “how much” is a decision made at the margin.

Suppose you are taking both economics and chemistry. And suppose you are a pre-med student, so your grade in chemistry matters more to you than your grade in economics. Does that therefore imply that you should spend all your study time on chemistry and wing it on the economics exam? Probably not; even if you think your chemistry grade is more important, you should put some effort into studying economics.

You make a trade-off when you compare the costs with the benefits of doing something.

Spending more time studying chemistry involves a benefit (a higher expected grade in that course) and a cost (you could have spent that time doing something else, such as studying to get a higher grade in economics). That is, your decision involves a trade-off—a comparison of costs and benefits.

How do you decide this kind of “how much” question? The typical answer is that you make the decision a bit at a time, by asking how you should spend the next hour. Say both exams are on the same day, and the night before you spend time reviewing your notes for both courses. At 6:00 p.m., you decide that it’s a good idea to spend at least an hour on each course. At 8:00 p.m., you decide you’d better spend another hour on each course. At 10:00 p.m., you are getting tired and figure you have one more hour to study before bed—chemistry or economics? If you are pre-med, it’s likely to be chemistry; if you are pre-MBA, it’s likely to be economics.

Note how you’ve made the decision to allocate your time: at each point the question is whether or not to spend one more hour on either course. And in deciding whether to spend another hour studying for chemistry, you weigh the costs (an hour forgone of studying for economics or an hour forgone of sleeping) versus the benefits (a likely increase in your chemistry grade). As long as the benefit of studying chemistry for one more hour outweighs the cost, you should choose to study for that additional hour.

Decisions about whether to do a bit more or a bit less of an activity are marginal decisions. The study of such decisions is known as marginal analysis.

Decisions of this type—whether to do a bit more or a bit less of an activity, like what to do with your next hour, your next dollar, and so on—are marginal decisions. This brings us to our third principle of individual choice:

“How much” decisions require making trade-offs at the margin: comparing the costs and benefits of doing a little bit more of an activity versus doing a little bit less.

The study of such decisions is known as marginal analysis. Many of the questions that we face in economics—as well as in real life—involve marginal analysis: How many workers should I hire in my shop? At what mileage should I change the oil in my car? What is an acceptable rate of negative side effects from a new medicine? Marginal analysis plays a central role in economics because it is the key to deciding “how much” of an activity to do.