Marginal Analysis Explained: The Efficient Decision-Making Principle for Economics

foreign principle which is this efficient decision makers use marginal analysis

okay so what's marginal analysis all right let me give you a quick definition and then I'm going to spend my time

explaining it this principle is a little bit more difficult than the ones we've talked about previously so we're going

to have to go through with more examples um so here's basically the definition of marginal analysis individuals weigh the

additional benefits against the additional costs when making a decision as a matter of fact anytime you hear the

word marginal economics you can substitute that word additional or incremental if you will and I'm going to

talk about how this works in just a second and what we're going to do is we're going to do what I like to call

the dollar bill game so that's what we're going to turn our attention to now it's just a simple silly game but it

allows you at least to see how marginal analysis Works in a simple framework and then I'm going to try to show you some

more complicated examples and how you can use marginal analysis uh to get the uh efit to get the efficient decision or

the the correct decision to try to understand marginal analysis we're going to do what I like to call the dollar

bill game it's really a simple silly kind of way of thinking of marginal analysis but if you keep the principles

of the game in mind as we go through more complicated things it should help you all right so what am I going to do

I'm going to offer you a series of deals all right and your basic choice is to accept the

deal reject the deal choice is up to you but we want to talk about how an efficient person whether they would take

the deal or not take the deal so uh here is the here is the first uh deal that I'm going to offer you okay I'm going to

offer you ten dollars I'm gonna put that number right there I'm gonna offer you ten dollars now in order to get the ten

dollars from me you're gonna have to give something right there's always a cost of action so you're going to have

to give up two dollars would you do it and the answer you should be saying is of course I would do it right you should

definitely take deal number one why should you take deal number one because I'm giving you 10 I'm only taking away

two it's going to leave you up eight right so I want you to imagine keeping that money on your desk in front of you

um and see and you can play with real money if you want to but it's not necessary so right now you have eight

dollars and what would your job is to try to get that money to go higher higher and higher here's the second deal

I'm gonna offer you eight dollars to in exchange for this eight dollars you're gonna have to give me four

now would you do that deal now sometimes students say oh I wouldn't do that second deal I wouldn't do it and I say

why wouldn't you do it they'll say it's not as good as the first deal yeah but the first deal is gone you've already've

already had the first deal um if you got that money on your desk would you do the second you should be

saying by the way yes I would do the second because it's an addition to the first deal right and the reason why I

should do the second is the eight dollars right this eight dollars is bigger than the four dollars this eight

is bigger than the four so you should definitely do that particular that particular deal right as a matter of

fact your money on your desk will rise from uh eight up to 12. can you see that eight from the first deal four from the

second you now have 12. now here's the third deal the third deal I'm going to uh give you

six and I'm gonna take away six would you do that deal

now somebody might be saying I'm not going to do that deal and I'd say why not because it doesn't give me anything

now notice by the way it doesn't hurt you either if you take the deal you'll still have twelve dollars left on the

desk okay so deal number one you should definitely take as a matter of fact if you stopped at deal number one and said

I don't want more deals that would be inefficient right you should take the second deal

now the third deal you might be saying I don't know if I want to take that third deal doesn't really do anything for me

somebody else might say it doesn't hurt you just give them you know give them a break take the deal let's leave it alone

okay and we'll come back to that deal and here's the fourth deal the fourth deal

I'm going to give you for and I'm gonna take away eight now um some of you might be saying

um take the deal I mean somebody might be saying take the deal that's not right right take the deal it's not right

um and the reason you shouldn't take this deal is because the number I'm giving you for is less than the number

I'm taking away from you eight by the way if you took that fourth deal and I know you're saying you wouldn't if you

took that fourth deal how much money would you have on your desk well you'd have eight from the first another four

from the second that would be 12. if you took the third deal there wouldn't be any problem with the third deal you

would just stop 12 and if you and if you took the fourth deal you'd still have eight dollars on your desk which is

better than you um there's more than you had before you started playing this game but it still wouldn't be good because if

you stopped at deal number two you would have had 12. so what's the efficient result well economists would say the

efficient result is for you to do the third deal is to go all the way up to deal number three now some of you are

saying I don't want to deal no deal number three why would I want to do deal number three and the reason why you'd

want to do deal number three is this um it has to do with the limits in the mathematics of this game that I'm

presenting to you how many numbers are there in mathematics between two and three

not in this problem but in mathematics between two and three I kid my class ones who said uh

uh there are three numbers between two and three and I said they're only three numbers but he said yeah two and a

quarter two and a half two and three quarters you're done um well hopefully your math knowledge of

Math's a little better than that there's an infinite number of numbers between two and three right there's 2.0001

Etc um there's and you can imagine there's just so many infinitesimally small

numbers that there's actually infinite numbers between two and three so what we say in economics is is that you should

go up to deal number three just before you got to deal number three technically that would be deal number two point nine

nine nine nine nine nine nine nine nine nine nine forever in mathematics we say that's in the limit you should go to

deal number three that would be that that would be the deal that's efficient technically it's deal number two point

nine nine nine nine forever um but we to make sure we say okay you just will include deal number deal

number three and that's because I'm not teaching with this with Calculus I'm just teaching you this with with limited

numbers so from this game you should be able to see what efficiency is this column right here is the equivalent of

marginal benefit and this column right here is the equivalent of marginal cost right this

is the amount of money that I'm giving you from every deal this is the gain that you're getting from every deal and

every deal comes at this additional cost and um the net gain is the difference

between the two right so um you would want look so what are we saying do deal number one yes do deal

number two yes uh don't do deal number four that's out um deal number three is that deal where

you're sure that you got the right amount of money if you take deal number three you'll be sure that the amount of

money that you're at the top of your desk at your desk would be at its highest magnitude that it would be 12.

and that's marginal analysis and the rule is pretty simple right let's take a look at that at that particular rule how

we could formalize it from the problem we just did the dollar bill game you can see the efficient make

efficient decision making rule if the marginal benefits greater than marginal cost as it was under deal number one and

deal number two you shouldn't stop you should do the activity more and if you keep on doing the activity more if the

MB is greater than the MC your your um your gain will grow right it went from eight up to 12 and keep going right if

the marginal cost is greater than the marginal benefit you should not do the active don't deal do deal number four

because deal number four takes away from your total right your your uh your totals and that problem went from uh 12

down to eight if you did deal number four so where is it efficient when the MB is equal to MC that's efficient

activity level that's how you should be doing things I don't care what the activity is you should always be doing

it in such a way that you do it just to the point where the MB is equal to the MC if the MB is greater than the MC you

do the activity more if the MC is greater than the MB do the activity less and when they're exactly equal you know

you can walk away I've done the the activity and efficient amount of times okay let's take a look at one final

question here let's imagine that John studied for his test the harder he studies the better grade he gets the

harder he studies the more time he has to give up to do it doing fun things now in this problem we're going to have John

measuring the benefits of activities and dollars and he measures the cost of activities and dollars economists like

to do that it's just easier to measure things in dollars if you think about it how much would you pay to get better

grades um that's not an offer by the way you don't pay me I'm not accepting but how

much would you pay there's some monetary figure you pay to get a better grade and also how much time would you pay how

much money would you be willing to give up to spend time with your friends all right so this final question uh John

measures the benefit benefits of activities and dollars he measures the cost of activities and dollars well John

has studied four hours for his test we've learned that the total benefits of studying the four hours are 28 dollars

and the total costs are 20. has John studied an efficient amount of time for his test that's my question to you isn't

given the numbers in this problem was four hours the right amount of time to study

now some students right away jump at the answer and say yes it is the right amount and I say why do you think so and

they say well because the total benefits are 28 right and the total costs are 20 and 28 is bigger than 20 and so you

taught us that the rule was if the benefits are greater than costs then you should do the activity

um that's that's a good thing and then some students say oh no you haven't behaved efficiently because the marginal

benefits the the benefits are supposed to be equal to the cost and that's a good decision but remember what I said I

didn't say anything about total benefits or total costs I said marginal benefits so those of you who are saying oh I know

that he's did a good job studying for this test because the 28 is bigger than 20. you've made a terrible mistake

because you have only been you've only been told the total the whole principle number five is that

we should be worried not about the total but the marginal the rule is if the marginal benefits greater than the

marginal cost then you've made a good decision so here just to show you imagine that the numbers that I gave you

for the dollar bill game are the same numbers for this particular question should he have studied the first hour

then yes because the marginal benefits greater than the marginal cost should you have studied the second hour yes

because the marginal benefits greater than the marginal cost should he have studied the third hour yes because the

marginal benefits equal to the marginal cost should you have studied the fourth hour

no because the marginal benefit was less the marginal cost look at this by the way what are the total benefits of

studying all four hours ten plus eight plus six plus four ten plus eight plus six plus four when you add those numbers

together that's 28. What's the total cost of doing it the uh studying four hours if these were the

numbers for studying 2 plus 4 plus 6 Plus 8 that's 20. that's this problem but we know that the efficient number of

hours efficient number of times to do this activity isn't four it's three because this fourth hour in this case

the marginal benefit is less than the marginal cost notice if you would stop studying at three hours right we're

gonna assume these deals are three hours if you would stop studying at three hours what would the numbers have been

if it would have been ten plus eight plus six ten plus eight is eighteen plus six is twenty four two plus four is six

plus six is twelve twenty four is greater than 12 and it's net gain of 12. by taking this fourth

deal by studying this fourth hour you actually reduce your gain from 12 down to eight so that would be a bad decision

now some of you might be saying wait a second you didn't say that these problems were related

no I didn't as a matter of fact the answer to this question has John studied the efficient amount of time for the

test is that you don't know and the reason you don't know is um it could be the case you could write

different marginal numbers and different marginal cost numbers that maybe you should have studied more hours

um you could do different numbers where he should have studied um he studied the right amount of hours you need to know

the marginals in order to know whether he made a good decision if these were his numbers he made a bad decision but

since the problem doesn't say what the marginal numbers are your answer is I don't know until I know the marginal

numbers so when you're given questions on tests it's not the total numbers that matter it's the marginal numbers that

matter you need to know the marginal numbers before you can um before you can determine whether

somebody made a good decision or not so how long should you study for a test you should study for a test as long as the

marginal benefit of studying is greater than the marginal cost the minute that the marginal cost is greater than the

marginal benefit you should should not study that time you should stop you should stop at the point where marginal

benefit equals marginal cost that's the efficient decision-making Rule and hopefully you can see you can see why

okay so now that you understand marginal analysis and how individuals make decisions right they uh weigh the

marginal benefit versus the marginal cost if the marginal benefits greater than the marginal cost of doing

something they shouldn't stop doing that activity they should keep doing it if they don't keep doing it they have

failed to behave efficiently they've got to do it more in order to behave efficiently the marginal cost is greater

than the marginal benefit it means they've done an activity too much they should be doing the activity less to

behave efficiently and if the marginal benefit equals marginal cost that means that they have done the activity the

efficient number of times that's that's what you're looking for where marginal benefit equals marginal cost that's an

efficient decision made a decision now how does this play out with maybe some everyday life examples all right so

let's say you go to your favorite Steakhouse let's say you go over here to on the Capital Grille and you get

yourself a double porterhouse oh you're excited it's it's two fillets and two strips put together and you're really

excited now furthermore you are going somewhere after this restaurant so you can't bring a doggy bag you're going to

be out um whatever you basically either finish the meal you don't finish the meal

whatever you leave is going in the garbage so let's imagine you eat this double

porterhouse and you take that first bite of course you do because the steak is awesome you take a second bite it's

delicious third bite you're still enjoying the steak um now my question to you is I want you

to imagine if you get all the way halfway through the steak and in fact if you take another bite of that steak you

are actually going to be physically sick all right you're with me another bite makes you physically sick

here's the question should you take another bite of the steak or should you walk away

now some of you are saying well what did I pay for this day well suppose you paid nothing for the

steak sometimes when I say did you pay not you paid nothing for the snake students say oh then I'll walk away who

cares I suppose you paid a thousand dollars for the steak should you keep on eating or should you

walk away now when I change that number A lot of times students say oh my gosh you got to keep eating the steak

but is that really using marginal analysis let's take a look is that really good efficient decision

making so let's think about it if you paid a thousand dollars for the steak all right and you take another bite what

did we say was going to happen you're going to be physically sick you can't finish it right and you don't like being

physically sick let's let's assume that's the case I do have a kid who said I don't mind it let's assume you don't

like being physically sick you take another bite you're gonna be physically sick all right

um let's assume you pay a thousand dollars for the stake and you um you don't take

another bite so you're not physically sick so those are two options right you pay a thousand dollars for the stake you

can take it out you can eat the entire steak until you're physically sick or you can pay a thousand dollars you can

half the steak and walk away when you're completely full what should you do well notice the thousand dollars doesn't

matter the thousand dollars is gone you're not getting the money back there's no restaurant that's going to

give you the money back and once you pay it it's what economists call a sunk cost it's not a marginal cost it's not an

additional cost you've already paid it so what should you do look at your options you take another bite you're

sick you don't take another bite you walk away from the stake you're not sick the only thing within your control is

being sick or being not being sick so what should you choose not sick it doesn't matter how much you pay for the

for the steak I could make the answer a million dollars for the steak the choices are still the same once you pay

the million dollars it's gone it's a sunk cost it's a cost that you're never going to get back no matter what you do

it's gone so therefore how should you make decisions remember what we said use marginal analysis weigh the marginal

benefits against the marginal cost so let's take a look at that in terms of the stake what is the marginal cost of

taking a bite of steak what are restaurants charging you every time you take a bite

I won't say the kids said well if I pay a thousand dollars for the stake and I took 100 bites that's not what I'm

asking you what are the restaurants charge you for every bite that you take they're not charging you anything unless

you go to a very strange restaurant right have you ever been to a restaurant where it goes on I saw you take a bite

that's an extra dollar no the marginal cost is taking a bite to zero we paid for the stake up front and then

they give you the stake and every time you take a bite it doesn't cost you anything but what does it get you it

gets you a marginal benefit right so if you're at that Steakhouse if you're at the Capitol Grill and you take that

first bite of steak if you love steak you're gonna take it of course because the marginal benefit is is is some

positive number and the marginal cost is zero remember if marginal benefit some positive number is greater than the

marginal cost which in this case is zero you should keep on eating the steak keep on eating it keep on eating it let's

fast forward in the story now we're halfway through the steak the next bite is going to make you sick

you don't like being sick that means the marginal benefit of that Next Bite is negative

the marginal benefit is negative the marginal cost is zero should you take that bite of course you

shouldn't because the marginal cost is greater than the marginal benefit that would be in a fish inefficient you

should stop eating the steak you should walk away that's good efficient decision making you shouldn't try to finish the

steak I don't care how much money you paid for it those are some costs you only should be weighing the marginal

benefits against the marginal cost did you ever hear the phrase cut your losses that's all we're saying with

marginal analysis sometimes you just got to cut your losses you only weigh the marginal benefit against the marginal

cost um the other phrase you might have heard is don't cry over spilled milk again

have you made a mistake by the way it's paying a thousand dollars for a steak that you can't finish yes but don't

compound your error by making yourself sick and spending the thousand dollars walk away when it's time to walk away

that's marginal analysis um I I once was talking to my mother who's a reasonably smart person and

she's like no no no you should finish the steak and I said that's not good decision making she said I think you

should finish the steak so I tried to use an example which would maybe explain it to her better I said

um what about um what about Disney World if you go to Disney World you pay money up front to

go into the park but then they don't charge you anything per ride so I said to my mother I said how many rides would

you like to go on on an Ideal day at Disney World and she said I don't know what you mean I said an ideal day how

many rides would you like to go on she goes I don't get it I said how about with this would you like to go a

thousand rides she said a thousand rides in a day I can't go on a thousand rides in a day no I'm not gonna go on a

thousand rides okay so I said something less than a thousand how about zero rides she says no I like rides I like

it's a small world I'd like to go on that I go well how many times would you like to go on rides she says I think I'd

like to go on rides 20 times 20 rides I said yeah she said I'll go on 20 rides I said you sure you want to pick 25 she

goes no I get it 20 and 25 I'd be running around too much uh what about 15 she goes no no that's too little I get

it you're being obnoxious so I said is there a number better than 20. she said no

20 is my best number I said imagine go to Disney World for free how many rides would you go on she said you're

obnoxious I've already told you 20. I said now imagine you paid ten thousand dollars for your ticket at Disney World

how many rides would you like to go on she says oh man I think I'd like to go on 25. no once you've paid the money

that's gone it's the sun cost once you already told me that 20 was the optimal number

20 was the number where Marshall benefit equals marginal cost don't make a mistake by trying to get your money back

you can't get your money back sometimes people say I'm gonna get my money back no you're not you're just making things

worse you weigh the marginal benefit versus the marginal cost I hope you get the exam the idea from these examples if

you don't I'll try one more when it comes to having a phone right there's a cost of having a phone you pay your

monthly bill and then what are they currently charging you for uh texting people generally speaking get unlimited

text right so I don't know how many texts you send in a particular month let's say you send about 500 texts in a

particular month could you send more of course because they're not charging you could you send less of course but you

choose to uh to text 500 times approximately a month now I want you mad let's say you pay a

hundred bucks for the phone it's expensive let's say you pay 100 bucks for the phone and you get unlimited

texting and you text 500 times now imagine the phone company says to you you know what we're going to raise

the cost of having a phone now instead of paying a hundred dollars to have the phone a month you're gonna have to pay

110. are you gonna start texting people more no because they didn't they changed the

price of owning the phone they didn't change the marginal cost of a text the marginal benefit of texting your friends

is still the same the marginal cost is the same nothing has changed on the margin therefore you'll still tax people

500 times the only thing that would get you to change your texting behavior is we'll see later when we talk about

incentives is if they change the marginal cost of of the tax if they raised a marginal cost if they charge

you per tax then you might start to CH uh to text less but that's the way um uh marginal analysis Works you're

just supposed to weigh the marginal benefits versus the marginal costs in making good decisions

okay there's kind of a philosophical way you can think about the issue of sunk cost you know kind of A Life Lesson sort

of thing um and I guess the best way to put it is this in this life you're going to make

mistakes maybe you've made some mistakes already I'm sure you have uh you're going to make more of them

um and one of the things that you're going to be faced with is how like that I've made these mistakes and some people

you may know or you may find yourself doing they dwell on the past they dwell on the past mistakes that they've made

but if you think about it that's just like dwelling on a sunk cost it's just like worrying about a sung cost which we

just said are irrelevant because once they're you've paid once they're paid they're gone

um and if you worry about some cost you're gonna end up making bad decisions so what is basically economic thinking

say um in terms of what does marginal analysis say about how you should

approach your life it should it says when you've made a mistake you should learn from it but then you should put it

behind you and you should focus on what are the marginal benefits and marginal costs in my behavior but if you're

constantly worrying about the mistakes that you've made in the past that'll paralyze you and you won't be able able

to make good decisions in the future uh listen you should try to avoid mistakes right we know that

um I'm not encouraging you to make mistakes but once you've made them learn from them move on move forward worry

about the additional benefits and the additional costs not the sun costs not the mistakes that you've made in the

past foreign okay so what are the public policy

applications of this marginal analysis let me ask you this how safe

should our world be how much crime should there be let's try that how much crime should there be a

lot of you saying well we should have a world with zero crime okay fine if that's what you think the

goal should be let's try to get zero crime how do we get zero crime well one of the things for example we could do is

we could uh increase the penalty so I'm going against the zero crime I got some ideas so the first thing I would like to

do is I'd like to get tougher on crime than we currently are so I'm going to Advocate let's execute shoplifters

anybody accused of shoplifting let's execute them um let's execute them for shoplifting

um I know you're like well what about higher crimes what about more serious crimes we'll torture you and then

execute you if your crimes are more serious right so if you've committed armed robbery we'll torture you a little

and then we'll execute you okay so this is a way of getting tough on crime now we also need more police officers

because we want to catch people we can't have anybody getting away with anything so let's put a police officer uh every

um 500 yards you know what that's not enough that's we're going to have people get away from get away with crime that

way let's a police officer every 10 feet every 10 feet in the society you have a police officer watching to see if you've

committed a crime and if they think that you've committed the crime of shoplifting we're going to uh sentence

you to death um and if it's worse than that torture and then death now let's get tough on

crime let's get to zero crime oh no but you know usually we have a some sort of a trial right so um right now um how

many how many people um what's what's the burden of proof in a trial burden of proof the burden of

proof is beyond A Reasonable Doubt it's very strong it's hard to get people convicted under a standard of Beyond A

Reasonable Doubt I think we should have a new standard small chance you did it that's the new

standard small chance you committed the crime we are going to um execute you or torture you and then execute you

depending on the crimes that you commit and you're definitely going to be caught because police officer is going to be

every every 10 feet um right now in the jury system how many

people do you need to convict somebody right all 12 right it's got to be unanimous verdict that's too hard let's

make it one guy one guy in the jury thinks that there's a small chance you committed the crime one of our uh police

officers we're going to find every 10 feet they're going to catch you and then we're going to try you then we're gonna

uh torture you then we're gonna execute you now we're getting tough on crime does anyone want to live in a society

that just described no I mean we might be getting tough on crime but it's really not optimal if you think about it

why not because in economic terminology the marginal cost of achieving zero crime is greater than the marginal

benefit we don't want to have a police officer every 10 feet I I don't I certainly don't I hope you don't either

we don't want to have um uh torture people and then execute them even for the smallest crimes we

don't want to have only one person uh say that you're guilty because we don't want to risk sending innocent people to

jail we want to have a high standard of proof because again we don't want to risk any innocent people to Jail the

marginal cost of achieving zero crime is simply greater than the marginal benefit so as an economist what I would say is

we're for the right amount of crime a tolerable amount of crime we're for the amount of crime we're what where the

marginal benefit of crime reduction equals the marginal cost of crime reduction that's how much crime we want

to reduce when the marginal benefit equals the marginal cost um is this going to win me any elections

if I'm running for office vote for me I'm for the efficient amount of crime probably not but it is actually the

right answer in terms of economic efficiency you can also apply this to the environment how clean should the

environment be a lot of you were saying I think the environment should be perfectly clean

is that really true should the environment be perfectly clean well think about what that would mean that

would mean that if there was one guy smoking a cigarette off his back deck somewhere uh you'd want to use the

United States infrared satellite technology find him and take him out no we don't the marginal cost of achieving

is uh imperfect environmental cleanliness is much greater than the marginal benefit so therefore we don't

want a perfectly clean environment now I'm not saying the environment is as clean as it should be that's a different

question for an economist the answer is how clean should the environment be how much should we clean up the environment

well we should clean up the environment to where the marginal benefit equals the marginal cost

um there's a lot of examples of this this kind of gets people upset how safe should we be

um for example now my my kids throughout their younger years have gone through active shooter drills where they've been

huddled in classrooms while people pretend that there's somebody going through the school on an active shooter

drill and people think that this is this is a good idea and maybe it is but I have to tell you from my perspective the

marginal cost of these active shooter drills were far greater than the marginal benefits to my kids my kids

were having nightmares every night about Shooters in the classroom and I actually would rather they didn't do the drill uh

and and I'd live with the consequences right now people get very upset when you say they say live with the consequences

don't you care about your kids I once had a woman in the back of the room who said

you're a terrible parent I said why am I a terrible parents she said because you apparently don't want your kids to be

saved I said you don't want your kids I do want my kids to be appropriately safe I don't want them to be perfectly safe

she said you're a terrible parent I said you're a terrible parent you don't want your kids to be perfectly safe she said

I absolutely do I said really did you send your kids off to school today and Kevlar vests uh were they wearing

helmets were they wearing safety goggles everywhere they went again of course not of course not again you right now you're

not perfectly safe as you listen to this this recording something could happen I could bore you literally to death you

could fall asleep while you're listening this economic lecture fall over hit your head on the desk and die where's your

helmet you've made a judgment the marginal cost of that helmet is greater than the marginal benefit so you're

willing to take on the risk and that's all we're saying the problem is when you say it out loud people get upset so you

got to be careful one of the terrible mistakes uh one of the terrible mistakes I made is a a student not a student I

was like a volunteer worker they were of students college student aid age and they came to my house you know one of

these volunteers who was trying to get you to sign a petition and this was a petition to clean up Long Island Sound

and they came to me and they said we want you to sign this petition to clean up Long Island South and I said to her

as an economist but oh is it too dirty she said is it too dirty and then she quoted some statistic about some

pollutant that was in Long Island Sound and I said is that too much or is it too little she said what are you talking

about anything is too much I said well no that's not true we don't want this sound to be perfectly clean she said of

course we do so I went into teaching mode and I tried to explain to her exactly right now as I did to you right

now how we really should be weighing the marginal benefits for system marginal costs and it it doesn't make sense to

get perfect cleanliness because the marginal cost of achieving that is greater than the marginal benefit well

she wasn't getting it so I tried to use an analogy you got to understand I was in teaching mode I wasn't really

thinking about how she might perceive this particular event so I said to him I said let me try another example I looked

at her and I said for example are you perfectly safe right now and here or here she was in this dark

and Street uh darkened Street up in up in uh right in the hallway uh getting me to sign a petition A stranger's house

and I'm looking at her and saying are you perfectly safe right now and she went oh I thought I was and I said well

guess again you're not and she said what do you mean I'm not I said are you wearing a bulletproof she said I didn't

think I needed to and here she is scared out of her mind and I didn't see it because I was in teaching mode but I was

trying to convince her that she didn't show up to my house perfectly safe that she had taken certain steps to be safe

but the marginal cost of a Kevlar vast or anything like that uh was greater than the marginal benefit but safe to

say she was scared out of her mind as I went through this analysis but again you're not people are not we don't want

the environment to be perfectly clean we want to be efficiently clean we don't want to be zero level of crime we want

an efficient level of crime we don't want to achieve perfect safety we want an efficient level of safety and how do

we find that efficient range we have uh you weigh the marginal benefits versus the marginal costs and that's how

economists use marginal analysis by the way everyone uses marginal analysis it's just the economist who says it out loud

and that sometimes gets them in trouble on these public policy issues again I'm not going to win any elections saying

I'm for a tolerable amount of crime um for uh the right amount of pollution for the right amount of safety but that's

essentially what we really are striving for each and every one of us in our own everyday lives we weigh the marginal

benefits versus the marginal costs okay one final thing I want to talk about now that you understand the word

marginal and marginal analysis and I want to talk about an economic concept that's going to come up a couple times

during this course and it's called The Law of increasing marginal opportunity cost the law of increasing marginal

opportunity costs so having discussed principle number four you understand opportunity costs having discussed

principle number five you hopefully understand marginal so I want to talk about this law of increasing marginal

opportunity cost so here's the definition of the law as you increase the production of one

good or service you will sacrifice an increasing additional amount of all other goods and

services all right remember opportunity cost means sacrifice so we're saying a

marginal means additional so I'm saying as you produce more of a good or service you're going to sacrifice an increasing

additional amount of all other goods or services so I'm going to try to explain this with

a very strange example that I use in my classroom that's going to be a little bit hard to do here but we'll be able to

do it you're just going to have to imagine so the question I normally ask my classes at this point in time is I

tell them that I have a very strange preference and my preference is for to is to teach

students with perfectly shaved heads okay that's my preference I would like every student to show up to my classes

with a perfectly shaved head so students typically don't want to show up with a perfectly shaved head so I

have to pay for the privilege of of seeing this done so what I'll do is I will offer a

certain amount of money for people to shave their head I might offer 500 for the semester by the way there are no

wigs there's nothing nothing I want to see the Dome you can't hide it with a hat

um I offer 500. so what typically happens typically at 500 I have one or two students who will

usually raise their hand and I'll tell you maybe you can guess what do you think those students look like

first of all they tend to be male students and they tend to have relatively short hair some of them are

completely bald to begin with why are they willing to do it 500 because for them the opportunity cost of

shaving their head is relatively small they're guys they have relatively short hair to begin with some of them are bald

so the so shaving their head is really a low opportunity cost why didn't the rest of the class raise their hand because

for them shaving their heads was a higher opportunity cost so to get more people to shave their heads what do I

have to do I have to raise the amount of money that I'm paying so I might off I might next up it to a thousand what

happens a few more guys jump in usually guys a few more guys with shorter hair again why because the opportunity cost

to them is still relatively low apparently it's a little bit higher than the people who were at 500 but it's

still relatively low why is it relatively low because they're guys in our society guys often wear they wear

their hair short some guys shave their heads it's not likely to generate a lot of looks or questions so it's a

relatively low opportunity cost but you know who's not raising their hands uh women in the class particularly women

with longer hair they have some very high opportunity cost of shaving their head so they choose not to shave their

their head their opportunity cost is too high but if I want more shaved heads and more shaved heads I want everyone in the

class to shave their head I'm going to have to offer more money and more money and more money sometimes it gets up to

almost uh sometimes it's as much as five million dollars I once said a class where one student it was actually a male

student who said I won't shave my head under any circumstances and when I asked why he said it was a religious objection

so I get why you wouldn't sell your soul for the money but that's a different story I did have one young woman who

said she wouldn't shave her head on for any any reason and I say this is a religious objection she said no it is

not and I said she said I just value my hair too much I think she began to stroke it a little bit at that time so I

said to her I said um I'll pay you 10 million she said nope not for any price I said I paid 20 million she said nope

not for any price of course it's easy to say that when it's actually playing money but I finally had to say to her I

will feed all of the world's starving poor if you just shave your head for the

semester she said not on at any price I told you so uh again sometimes people are are selfish I guess but

when it comes to this particular um this particular example notice what's happened

how much did the first shaved head cost me cost me five hundred dollars the second shaved head might have cost

me an additional six hundred dollars the fourth and fifth shave head might have cost me a thousand dollars the 34th

shave head five million dollars notice what's happening the cost is going up up up and up for going to go from zero

shaved heads to one shaved head it only cost me five hundred to go from 33 shaved heads to 34 shaved heads it cost

me five million notice it's an increase in one both times right zero to one is an increase of one thirty three thirty

four is an increase of one but it from zero to one cost me 500 from 33 to 34 cost me five million the opportunity

cost has changed now why is this law occurring well if you think about it the law is occurring it's not because

resources are scarce I know sometimes it's a popular answer resources are scarce that's why the laws occurring

because think about it if I want an unlimited amount of Shades shaved heads and I only have 34 students in the class

but those 34 students are identical to one another let's say they're all guys who are fault how much does the first

shave tank going to cost me 500 what's the second shift that gonna cost me 500 what's the third shift they're gonna

cost me 500. what's the 34th shave type going to cost me 500. it's 500 all the way through because even though my

resources are limited I only have 34 of them they're identical so the opportunity cost stays constant it's not

increasing but suppose I by the way suppose I had a class of of uh girls with long hair and

the first shaved head costs but they're identical every girl is exactly the same same preferences what would the first

shift head cost me five million what's the second shift that cost me five million what's the third shift that cost

me five million not an increasing opportunity cost the opportunity cost is constant so when you take a look at this

what's driving the law how come I had to offer 500 at first but only but I had to offer a 5 million for the 34th shaved

head and that's because resources are specialized they're not interchangeable people are better suited for some things

some tasks than others uh in my example the men in the class tend to be comparatively better at having their

heads shaved the women in the class were comparatively better at having their head uh their their hair grow long

um so when it comes to the law of increasing opportunity costs what's the reason behind it it's not that resources

are scarce that's not the reason behind that resources are scarce means there will be an opportunity cost but the fact

that the opportunity cost is getting larger is due to the fact that resources are specialized some people are better

suited to some tasks other people are better suited to other tasks and that's the law of increasing opportunity cost

in a nutshell right remember what the law says as I increased the production of one good or

service then I will sacrifice an increasing additional amount of all other goods and services

to um to get the first shaved uh to get the first hit shave that it cost me 500 uh for the first shaved head that's a

that's like an overnight vacation to get the 34th shave head it's going to cost me a mansion on on Long Island

that's a significantly different cost and the reason is because resources are specialized

just one final note on how you have to be careful in the way that you use um economic analysis and in this case uh

marginal analysis um I I received a email from a student um a couple years ago very fine student

and um and this is what she told me about the impact that my class was having on her life and it says hello

Professor Frost I thought you would enjoy hearing about how economics is ruining my life I recently used marginal

analysis to explain to my boyfriend that if the marginal cost of our relationship was greater than the marginal benefit

economic theory tells me I should date him less he was not at all pleased by my analysis

I hope I got the economics of it right because my greatest fear is not that we would break up but that he would walk

away with a flawed understanding of this revolutionary economic theory because I explained it incorrectly

I guess I thank you for opening my eyes I say that as sincerely as I can even though it sounds sarcastic economics has

definitely given me in a deeper appreciation of the phrase ignorance is bliss

now this is what I'm worried about I want to use economic analysis it's okay that you use economic analysis in

analyzing your decisions if the marginal cost of her dating her boyfriend was greater than the marginal benefit of

dating the boyfriend then she should break up with the boyfriend she's right about the economics and it's a and it's

good efficient decision making but please please just be careful in how you say this to people because they're gonna

be upset and I don't want it to come back to me but it is a nice illustration of how use

uh marginal analysis to govern your own everyday decision making and that's why I read it