Robert Murphy expalins what it means to act “on the margin” or to think in terms of “marginality?” Economists use the term often. The Mises Circle in interwar Vienna even had songs with refrains that included the words “Marginal Utility.” Here is your one-article guide to understanding what all the fuss is about. [FULL ARTICLE]
Source link: http://blog.mises.org/2342/what-does-marginality-mean/
What Does Marginality Mean?
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I thought it meant the call you get from your broker when you buy Dow Jones Industrial Depository Receipts (DIAmonds) using money borrowed from the broker, and the price tanks.
That stupid remark by the guy who didn’t want to chip in to remove the tree actually CAN make sense in a marginal analysis if you overlook his wrong reference to how much he’s spent on the house and look at how much money he’s got left after doing so. If he had turned his remark around the other way and said, “Well, now I’ve got so little money left after the renovation that AT THE MARGIN I need what’s left for things that are even more urgent than that tree,” then it all fits in with marginal analysis. But that comment about having put too much into the house is a fine example of the upside-down thinking that most people do in matters such as this.
Since when is praxeology supposed to critique people’s purchasing habits instead of explaining them?
The way the article referred to sunk cost was as if it was something that people should do. That’s meaningless when we’re in the realm of pure economic analysis. Sunk cost is an idea that explains how all people act; it is impossible to point out examples to the contrary as it is true a priori.
Thus, I have a problem with both the restaraunt and the tree example. Both came off as entirely prescriptive, and came dangerously close to sounding like marginality could be violated at all.
The tree example is made even more understandable when we realize that the man clearly enjoys his property, house and landscaping together, as one good. Thus, he feels that he has spent spent as much as he wants to on the forseeable future on this good and would receive a higher marginal benefit from other goods.
The comments of either man were neither stupid nor foolish. They tacitly recognized the effect of their previous purchase decisions on their present budgetary constraints and thus potential marginal benefits, even if they are unable to academically articulate that relationship.
In using these kinds of examples, then, it should be stressed that the people involved are not being stupid or irrational, but rather that they themselves are not conscious of the praxeological laws that are influencing them whether they realize it or not.
Adam, the only question on the tree that should be raised is whether or not removing the tree is worth the marginal cost. While the man may have meant that because of his previous actions the utility of the money used to remove the tree is greater than the value of removing the tree, he did not say this. Instead he decided not to judge the marginal value at all based on a previous decision (or so the author implies) which is foolish.
The real error in the article is that MLB minimum salary is $300,000/year so no baseball player makes $250,000/year (minor leaguers generally make well under 250,000/year).
The best explanation I have ever seen of the marginal theory of values is in Harry Browne “How to Profit from a Monetary Crisis” under the heading “Underpricing”. Well worth a read if you can find a copy.
Braden, you missed my point; if you think that not judging on the margin is foolish, you clearly don’t understand the theory of marginal utility.
Not judging on the margin is impossible. It cannot be done, not by the man with the tree nor by anybody else. Everyone makes decisions on the margin, in all times and in all places.
The man most likely could not articulate his preferences, but that only makes him ignorant of economic theory, not a fool. In fact, what he understands that you do not and cannot (except in terms of consequences) is how his previous expenditures, while sunk costs in themselves, have effected his current structure of preferences.
Adam appears to be right : decisions are always made on the margin, based on one’s preference structure at a given point in time.
However, I think it would be fair to say (and I assume this is the point of the article), that an entrepreneur who assigns a high value (utility) to “persisting in an investment which turns out to be a poor one -and without realistic prospects for improvement- because it makes him feel awful to take his losses and recognize his previous decision was poor” is unlikely to be successful – as he will probably be caught by the reality of cost accounting.
That being said, people do not always act as entrepreneurs, nor should they have to!
The comment by Lawrence seems to make a lot of sense to me. One could suspect that the utility of the described decisions are not fully explained by monetary considerations. Especially as these are obviously observations from day to day life.
Another problem that strikes me is that the decisions are made at different points in time. So it is very likely that preferences of the particular person and therefore also utility will have changed.
The example of the gym membership shows this clearly. At the point of paying the 1000$ fee the person might have a strong preference to being physically active, also (s)he knows that this preference is going to change for the worse. So with this being the case, the utility of the decision to pay so much money to a large proportion results from the fact that (s)he now ist “forced” to be active. “Forced” is not the right word, the marginal utility of the daily decision to actually work out rises because the person “feels better” also because the marginal cost as well as the average cost for every workout is falling everytime you go.
(Sorry for the poor language, I’ve never written a piece of economic text in English before)
How would one apply this argument of margin to the war in Iraq? Are we speaking here of individual decisions, or would this apply also as a “collective” decision for “national interest”?
Can such marginal decisions be made in a collective fashion? Would someone address this?
Adam, I agree that he must be acting with marginal judgement. I think that a typo in my comment gave you the impression that I thought that not doing this was impossible, what I mean say was that in this case he is measuring the marginal value of his action against the marginal cost of not only that action but also the previous action (which is foolish).
rhaulk,
The collective cannot act.
Braden-
You’re closer, but you’re still missing an important point. Someone cannot simply decide to take into account sunk costs; everyone only decides on the margin. The man with the tree has simply integrated the cost of the renovation into his present structure of possible costs and benefits. There is nothing foolish in that at all. I do the same thing all the time.
Just as it is impossible for praxeology to show that someone should do some thing without a specification of a specific array of ends is to be pursued, it cannot judge a person’s action as foolish unless there is an end in question which will obviously not be achieved by the action in question. Even then, it can only judge the means as foolish, not the end.
Adam,
The author seems to imply that in this situation (which despite being “real” still requires assumptions) that the marginal value of the person’s money and the marginal utility of the action have not changed based on the previous work (I do not think this can ever be the case). If this is true than using the past event to justify the current action is foolish (since nothing changed based on that past event).
I thought that the author was being a bit harsh on me, sorry, the hypothetical Man In The Restaurant. He goes to the restaurant because he´s hungry, orders the wrong dish and has to pay $100 for it. Now it is one thing to stipulate that if the man “would rather go hungry than force down the meal if it were free” he should do the same here. But I would suggest in the majority of cases that while he is saying “I might as well get my money´s worth” (perhaps to save some kind of face), he is really thinking, “well, I came all the way out here to eat, I haven´t eaten and I´m still hungry.” He can either starve…or fork out more money for another, milder dish. Thus, he considers the extra money he will then have to pay for another dish (assuming he decides to eat the hot dish already on his plate) less desirable than just going ahead and eating the hot dish and the attending “cost” to his digestive system.
Or is it just me?
Another way of conceptualizing the “Ballplayer versus teacher salary” issue is in terms of leverage, which Murphy alludes to. Essentially, how many payors (and what are they willing to spend) relative to the supply of acceptable workers. We could find talented baseball players who would be willing to accept modest salaries, but if the market demands top notch athletes we will pay a premium for them. The same goes for rock stars: as long as there are a great many people willing to spend big bucks on only their favorite artists, these select few will make out like bandits. It’s also what makes our lotteries work!
As I read this article, I realized for the first time that there is a correspondence between “marginal” thinking and, what is advocated in the spiritual traditions, living in the moment. That is to say, in order to make optimal decisions, we need to let bygones be bygones, and operate in the present. I find this fascinating.
Yeahh Your artical was great..
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