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♪ [music] ♪

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- [Alex] In economics,

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you're likely to hear[br]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

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a little bit more[br]or a little bit less.

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Let's imagine[br]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[br]just a little bit.

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[voices coming from movie]

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How high should you go?

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

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to the marginal cost[br]of increasing the volume.

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The first notch up sounds good.

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Now you can hear[br]what the actors are saying.

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[slightly louder voices]

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You increase it another notch.

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[louder voices]

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

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[louder voices]

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One more notch.

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[explosion]

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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[br]your roommates!

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So you decrease it a notch.

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[quieter voices]

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You keep doing this,

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making marginal adjustments[br]up and down,

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comparing the marginal benefit[br]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[br]of the next decision to its cost.

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Notice that thinking[br]on the margin --

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it's a method or way of arriving

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at an optimal or best decision.

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

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you might have trouble answering.

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But if you keep thinking[br]and acting on the margin,

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you'll come to a point

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where the marginal benefits[br]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[br]and finding an answer

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to a problem that might otherwise[br]be quite difficult.

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Thinking on the margin

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also tells you something else[br]of importance:

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what not to think about.

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Let's imagine you run[br]a small clothing shop,

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and you think that the 1970s[br]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[br]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,[br]including rent and wages.

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

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- [Funny voice] What?[br]- 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[br]below $100,

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you're guaranteed to take a loss.

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[scream sound effect]

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Fortunately, you had[br]a good Economics class

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in high school or college,

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so you remember[br]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[br]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[br]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[br]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[br]businesspeople --

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they often focus too much[br]on what they paid for an item

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and not enough[br]on their best choices right now.

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It's called the sunk cost,[br]or fixed cost fallacy.

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

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Did you catch it?

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

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a price that will cover your costs,[br]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[br]in huge demand, for example,

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then you should price them[br]for more than $100.

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What you paid for the jeans[br]is irrelevant --

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whether your decision[br]was a bad one or a good one.

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

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especially holding on[br]to past mistakes.

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Maybe you've been told, [br]"Never give up!"

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Well, take the advice[br]of an economist.

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Sometimes giving up[br]is the smart thing to do.

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Is the movie[br]you're watching boring?

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Well, buying the ticket[br]was a bad decision.

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But that cost is sunk.

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Don't throw good time after bad.

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Walk out!

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No one likes to admit[br]that they made a bad decision,

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and so they stay[br]in bad relationships,

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bad businesses, and bad careers,

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hoping, hoping[br]to turn things around

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

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An economist says, [br]"Ignore what you can't change.

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Ignore the past.[br]Focus on the future."

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Let's summarize[br]thinking on the margin.

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First, think about[br]a little bit more

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or a little bit less,

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and keep going[br]until you'll arrive at a point

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where the marginal benefits[br]equal the marginal costs.

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That's the optimum.

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Second, when making a choice,

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only think about[br]the costs and benefits

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that change with that choice.

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Ignore sunk costs.

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Thinking on the margin --

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it's useful,

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and not just for Economics classes.

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But if you are teaching[br]an Economics class,

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check out our free unit plan[br]that incorporates this video.

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I promise, the marginal benefit[br]will exceed the marginal cost.

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And if you're ready[br]to test yourself,

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check out our practice questions.

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Finally, if you're ready[br]for more microeconomics,

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click for the next video.

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♪ [music] ♪