The Margins Principle

Economics is about behaviour and behaviour is about decisions. The margins principle is a reminder that most decisions involve concern small variations in a margin of adjustment. This idea is probably the second big lesson taught to students in their first economics course. In classes, this principle is seen in jargon such as “marginal utility”, “marginal cost”, marginal benefit”, “marginal revenue”, and “marginal rate of substitution”.

Yes/No decisions are dramatic but there are very few questions or decisions where the only possible answers are “Yes” or “No”. Different types of economic puzzles emphasize different margins and, once you know to look for the margins, you should begin to see that claims about Yes/No behaviours asserted by others oversimplify. A very short list of examples includes

• Consider the behaviour of a consumer when shopping. If you think that his or her only possible decisions are “buy” or “don’t buy” then you do not understand their problem from their perspective: a consumer can also buy later or buy a little now (and a lot later) or buy a higher quality or buy some of this good and some of a substitute or …
• On the seller’s side of a market, even if a firm has decided to enter a market, the obvious margins of adjustment include the quantity of production, the quality of the production, which segment of the market to ship to, whether production uses a capital-intensive or labour-intensive process and so on.
• Government regulations written by lawyers might seem to be an example of a Yes/No decision. In practice, highly paid lawyers are very good at finding loopholes which smooth off the hard corners of the law. Or, a government may delay implementing the law or budget cuts may change how strictly the law is enforced.
• An important advanced application of this principle is evident in sports and games. Consider the game of “Rock-Paper-Scissors” which is played all over the world and has a world championship https://wrpsa.com/rock-paper-scissors-tournaments/. Each player is trying to figure out a winning strategy: e.g., should I play Rock because it will intimidate the other player or should I not play Rock because that is what women expect men to play? Thinking about the margins principle indicates that thinking that there are only three choices is misleading. You can choose probabilities between 0 and 1 for each of Rock, Paper and Scissors. (This insight is extended with the concept of a “mixed strategy Nash Equilibrium”.) You can also add talking strategies before the actual move: i.e., deception, bluffing, and reputation.
• You may think that setting an alarm at night is a Yes/No decision but, in the morning, you can always hit the snooze button for 10 more minutes, repeatedly. Sellers of alarm clocks https://www.mattressclarity.com/reviews/best-alarm-clocks-for-heavy-sleepers/ have also found many ways to change the design of a clock to be more effective.

Oversimplifying a question or adding an unjustified assumption often leads to confusion when confronted with reality. These examples, and many others, illustrate why realistic economic analysis does not limit the possible choices to only Yes and No.

Any discussion of marginal adjustments in the context of a decision leads naturally to a related bit of jargon, such as “diminishing marginal productivity” or “increasing marginal cost”. Some test questions are intended to reveal lazy students who do not see the meaning in the jargon and, despite much class time discussing the differences between total cost, average cost and marginal cost, who think that the meaning of “cost” is unambiguous. These test questions are important because the fact that marginal cost varies with the level of output is critical when a manager needs to decide how much output to produce (i.e., the possible answers are more complex than “More” and “Less”). Beyond doing well on questions designed to trap lazy students, the idea of diminishing marginal productivity means that, sometimes, the profit maximizing solution to a workplace problems is something other than “work harder and longer”.

The margins principle might be the most useful to somebody who approaches business from a transaction perspective. A person who focuses on a transaction may think (inaccurately!) that the quantity to be bought or sold is fixed and that only the price needs to be negotiated. They ignore the possibility of changes in scale, quality or timing (including the possibility of future business with this customer or with their friends). A transaction perspective encourages negotiators to split the difference between what a buyer is willing to pay and what a seller is willing to accept. This is not real negotiating, especially since splitting the difference is easy to manipulate. A better negotiator finds opportunities that a weaker negotiator misses, by adjusting other dimensions of an agreement (such as quality or volume) in order to make a price acceptable.

Overcoming these kinds of mistakes in thinking enables people to think more accurately about the shape of a demand curve or a supply curve and about the forces which determine negotiated prices in the short run and in the long run.

Now it is your turn to write.

1. I provided some general examples of margins in the discussion above. They are popular in economic discussions and relevant. Have you seen more unusual examples of margins of adjustment?
2. If you are familiar with a particular industry, have you seen any odd bits of jargon that are understood by a few insiders to that industry but reveal margin of adjustment. Does the jargon reveal an implication of diminishing marginal benefit or of increasing marginal cost?
3. A pair of more provocative questions are: Have you seen a change in any situation which makes the margin evident? What is it about the change that increases or decreases the effectiveness or significance of the margin?

Hint: Consider an example provided by a former student of mine. When applying for a job, applicants are often advised to submit a resume with only one or two pages. This student could avoid this restriction when the resume was screened by an “automated tracking system” (ATS) first: he could include minor bits of information, such as obscure keywords, without exceeding the limit by entering the words in a very small white font. Even if a human would not see them printed on white paper, the computer would recognize words and the student could pass the first screen.