Marginalism and the Law of Equal Marginal Advantage ________________________________________________________________________________________________________________________________________________ All decisions are at the margin. Unknown (an economist’s cliché) People’s decisions tend to be marginal (incremental) processes. Microeconomic analysis stresses how people optimize, which usually entails balancing expected marginal benefits against expected marginal costs. These balancing acts occur when individuals attempt to maximize personal satisfaction, and when firms try to maximize profits. Bankruptcy looms for marginal firms; and marginally passing an exam puts you in danger of failing. Economists often refer to a marginal unit of something as its extra or last unit. Just as a sheet of paper is bordered by margins, the last few bits of a thing are commonly described as its margins, which can be misinterpreted as specific units. For example, if there are 30 students in your class, who is the thirtieth? If anyone drops the course, only 29 students would be enrolled. Thus, each of you is the thirtieth (marginal) student. (Does that make you uneasy?) Similarly, there is no way to identify the last (marginal) slice from a pepperoni pizza until the rest are eaten, nor is there a way to detect the marginal (last?) worker hired—or laid off—by IBM. Each unit of any group may, in a sense, be the marginal unit. (Marginal changes are commonly written by preceding the symbol for the changing variable with a Greek capital delta (Δ)—e.g., a price (P) change is written ΔP.)[1] Even large changes can be treated as a series of small changes. For example, suppose warm cookies, fresh from the oven, are your favorite snack. You don’t look at a plate of cookies and plan to eat exactly six cookies. Instead, perhaps unconsciously,. you weigh the cost of the first (market price, calories, etc.) against its expected ability to satisfy you. When the marginal benefits of extending any activity exceed its marginal costs, you proceed, so you eat the first cookie. Then you consider whether to eat a second. Each decision about whether to have another cookie occurs one at a time – incrementally, also known as at the margin. If, subjectively, the expected marginal costs exceed expected marginal benefits, you stop (or even reduce the level slightly). If you do eat a second cookie, you then decide whether to eat a third. And so on. Similarly, firm managers usually adjust operations marginally rather than deciding whether, for example, to shut down completely or to grow by doubling their workforce. Instead, they decide whether to increase their hiring by balancing how much a bit more extra labor might cost against the additional revenues that an extra worker might be expected to generate. This may not seem obvious at first glance, because marginal decisions (such as switching brands of pasta or a firm merging a couple of small departments into one larger one) rarely make headlines.In these contexts, such words as incremental, extra, and additional all refer to decisions at the margin. Decisions about buying (demanding) or selling (supplying) are almost invariably based on opportunity costs, which ultimately depend on the relative marginal benefits and costs of goods. For example, you probably eat less from a menu where prices are a la carte than if a restaurant charges a fixed price for a buffet; “all-you-can-eat” pricing causes you to view the cost of extra food as zero. The Law of Equal Marginal Advantage Optimization requires economic efficiency—minimization of the costs incurred in accomplishing any given task. Before studying the core of theory that lies ahead, you should be familiar with a concept that governs all optimization processes. The law of equal marginal advantage requires equivalent goods or similar resources to be allocated in equally advantageous ways at the margin. Failure to conform to this principle is inefficient. For example, if the last dollar you spend on rhubarb fails to yield the added pleasure you would receive were it spent on an extra hot fudge sundae, you will gain by spending less on rhubarb and more on sundaes. People generally change their patterns of consumption or production whenever resources (in this example, the command over resources represented by your last few dollars) are inefficiently allocated. Thus, you would gain by eating an extra sundae and a bit less rhubarb, and undoubtedly make these sorts of adjustments with very little conscious thought. You settle into a stable consumption pattern only when the last cent you spend on any single good yields satisfaction equal to that gained from the last cent spent on any other good. Similar marginal adjustments span the realm of economic decisionmaking. Here is an example drawn from choices about work. Suppose that you and your identical twin are equally strong, experienced, and intelligent. If your twin works an 8-hour day and produces $64 worth of mowed lawns while you generate $48 worth of cleaned windows with similar effort, something is wrong. You will (and should) shift into mowing lawns so that your labor resources are allocated equally advantageously, at $8 per hour instead of the $6 per hour you have been earning. Economic inefficiency exists whenever equivalent resources are not used to equal advantage. Other applications of the dictate that efficiency requires similar resources to be allocated in equally advantageous ways at the margin include the notions that: 1. People's time must be divided between work and leisure so that the gain in income from the last hour an individual works (the individual's wage) just equals the subjective value of the last hour of leisure enjoyed. 2. The last dollar a firm pays for labor must generate the same amount of extra production (and profit) as the last dollar spent on capital or land. 3. The dollar value to a consumer of the right to consume a particular good must equal the value of other production that society sacrifices in making that marginal unit of the good available to that consumer. Don't worry if these applications of the law of equal marginal advantage seem a bit murky at this juncture. As you continue through this course, you will constantly encounter its corollaries and will see that competitive processes tend to drive a market system so that this requirement for economic efficiency is met.
________________________________________________________________________________________________________________________________________________ Author: Ralph Byrns
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[1] Economic "marginals" often refer to the ratios of changes in one thing in response to small changes in another. For example, the marginal physical product of labor is output generated by adding an extra hour or labor to a production process (Δoutput/Δlabor), and the marginal propensity to consume is the proportion spent on consumer goods out of any extra income (Δspending/Δincome).