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♪ [music] ♪

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In economics,

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you're likely to hear
the word "marginal" a lot:

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marginal benefit,

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marginal cost,

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marginal revenue--

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the list goes on and on.

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So what is thinking on the margin,

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and why is it important?

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Marginal just means
a little bit more

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or a little bit less.

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Let's imagine
that you're watching a movie,

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and you can't hear the dialogue.

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You increase the volume
just a little bit.

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How high should you go?

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Well, that's a question
of comparing the marginal benefit

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to the marginal cost
of increasing the volume.

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The first notch up sounds good.

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Now you can hear
what the actors are saying.

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You increase it another notch.

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Speakers are distorting a little, 
but you still prefer it.

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One more notch.

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Uh-oh!

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Now there's an action scene.

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It's too loud!

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You don't want to wake up
your roommates.

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So you decrease it a notch.

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You keep doing this,

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making marginal adjustments
up and down,

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comparing the marginal benefit
to the marginal cost,

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each step of the way.

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Thinking on the margin

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just means comparing the benefit
of the next decision to its cost.

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Notice that thinking
on the margin --

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it's a method or way of arriving
at an optimal or best decision.

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If I asked you for the best volume
to watch a movie,

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you might have trouble answering.

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But if you keep thinking
and acting on the margin,

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you'll come to a point

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where the marginal benefits
equal the marginal costs --

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that's the optimum.

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So thinking on the margin

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is a way of searching for
and finding an answer

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to a problem that might otherwise
be quite difficult.

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Thinking on the margin

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also tells you something else
of importance:

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what not to think about.

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Let's imagine you run
a small clothing shop,

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and you think that the 1970s
are about to have a renaissance.

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I remember those times!

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♪ [music] ♪

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So you load up on 100 pairs
of bell-bottom jeans.

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Let's say you paid $75 a pair.

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You price the jeans at $100 --

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a price that will cover your costs,
including rent and wages.

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But unfortunately, the jeans --
they just don't sell.

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What do you do?

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You think about lowering the price,

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but your accountant tells you

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that if you lower the price
below $100,

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you're guaranteed to take a loss.

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(scream sound)

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Fortunately, you had
a good Economics class

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in high school or college,

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so you remember
that what you paid for the jeans

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is irrelevant.

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That cost is sunk.

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What matters now

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is to compare the marginal benefits

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and marginal costs of your options.

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One option would be to put
the jeans in storage and hope --

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hope they'll come back in style.

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Maybe you can get $100
per pair in the future,

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but you get no money now,

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plus you have to pay for storage.

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Another option is to slash prices.

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Sell them all now for $50 each.

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That lets you clear out
your inventory

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and invest in something else.

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You choose option two

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and invest in the next big thing:

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leg warmers!

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Now, I know this sounds simple,

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but actually, even experienced
business people --

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they often focus too much
on what they paid for an item

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and not enough
on their best choices right now.

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It's called the sunk cost
or fixed cost fallacy.

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In fact, I snuck an example
of the fallacy right past you.

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Did you catch it?

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Earlier, I said you price
the jeans at $100 --

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a price that will cover your costs,
including rent and wages.

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But that's also wrong.

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If bell-bottom jeans turn out to
be in huge demand, for example,

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then you should price
them for more than $100.

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What you paid for the jeans is irrelevant,

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whether your decision was
a bad one or a good one.

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People fall prey to this
kind of error all the time,

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especially holding on to past mistakes.

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Maybe you've been told, never give up.
Well, take the advice of an economist.

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Sometimes giving up is
the smart thing to do.

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Is the movie you're watching boring? Well,
buying the ticket was a bad decision.

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But that cost is sunk. Don't
throw good time after bad.

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Walk out! No one likes to admit
that they made a bad decision.

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And so they stay in bad relationships,
bad businesses, and bad careers,

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hoping, hoping to turn things around

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and prove that their past
decisions weren't so bad after all.

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An economist says, ignore what
you can't change. Ignore the past.

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Focus on the future. Let's
summarize thinking on the margin.

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First, think about a little
bit more or a little bit less,

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and keep going until you arrive at a point

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where the marginal benefits equal the
marginal costs. That's the optimum.

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Second, when making a choice,

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only think about the costs and
benefits that change with that choice.

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Ignore sunk costs.

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Thinking on the margin, it's useful,
and not just for economics classes.

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But if you are teaching
an economics class,

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check out our free unit plan
that incorporates this video.

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I promise, the marginal benefit
will exceed the marginal cost.

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And if you're ready to test yourself,
check out our practice questions.

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Finally, if you're ready for more
microeconomics, Click for the next video.