The ability to think on the margin is one of the fundamental principles that economics teaches us. Thinking on the margin is the technique of thinking about the next increment only. How should I spend my dollar number 1? How should I spend dollar number 2? So on and so forth.
Chapter 2 of Making Great Decisions in Business and in Life talks all about thinking on the margin and a couple of other topics as well. Let’s dig in!
The chapter opens up with an example comparing two different situations:
Situation one: Would you rather try to survive for a year without water or without diamonds? Obviously, you would rather choose the water over the diamonds or you will be dead within the first month. It is easy to live without diamonds as I haven’t ever owned one and probably never will.
Situation two: If you could win one of the following two prizes in a contest, which would you pick – a bag of diamonds or 50 gallons of water? If you were smart, you would choose the diamonds because they are worth a lot more in the current market.
It’s kind of ironic that the thing you can’t live without is worth so much less than a luxury item like diamonds. Henderson and Hooper explain, “In situation one, choosing diamonds means you try to live without all water for a year. In situation two, choosing diamonds means that you add to your existing wealth, which includes, perhaps, a diamond or two and enough money to buy as much water as you need.”
Maslow’s Hierarchy of Needs is a theory created by clinical psychologist Abraham Maslow. It states that as people grow and develop, they move up a ladder of needs, from more basic to more advanced. If we have nothing, what do we want most? Basic physiological needs like food and water. After we have those, what do we want? Health, property, additional resources, etc. If we slide back down the ladder, then our priorities change (like in the most recent recession). Maslow’s theory is thinking in increments, which is thinking on the margin.
The example above also reflects upon the stock price of many publicly traded companies. What is currently the most valuable publicly traded company? Apple, which has a significantly higher valuation of than Exxon Mobil, which is second on the list. How does Facebook have almost twice the wealth than Monsanto, the leading agricultural biotechnology company? It’s because our society’s next increment is way past food and fossil energy, and is on technology and communication.
Thinking on the margin is so important in business that it needs to become second nature to you. You invest your money into efforts that are going to maximize your profits. For every economic decision that you make, you need to look at the marginal return for that decision. Should I hire one additional salesperson? Should I spend an additional dollar on pay-per-click marketing? Should I send out another email newsletter to my clients?
The opposite of thinking on the margin is using averages to make decisions. We all do this sometimes, but we rarely make decisions about averages. I’ve recently consulted with a client who would not invest more money into a social media campaign because it would lower his average profit per lead for the entire campaign. A person thinking on the margin would have invested the extra money into the campaign because the additional revenue from the extra push would have exceeded the cost of it.
Most productive people think on the margin, even if they don’t articulate it in those terms. When I am most productive, I ask myself “What are the tasks that I can do today that will produce the highest ROI for my time?” When I am least productive, I waste my scarce time doing menial tasks at best and playing around on Facebook at worst. In “The Four Hour Workweek” by Tim Ferris, he talks about writing down your five most important tasks on a half-sheet of paper and make sure that you do those things no matter what. This will result in the maximization of your time, even if that means you working only a few hours per day.
The progression of equality is an exercise of thinking on the margin. During the Civil Rights Movement, leaders like Martin Luther King Jr., Thurgood Marshall, and Medgar Evers worked tirelessly to pass laws that guaranteed political and educational equality. Fast forward fifty years and we find that there isn’t much more that we can legislate. We can either continue to spend resources finding more laws to pass or move those resources to areas that produce higher yields.
The new frontier of community building is with economics. MLK realized this and was going to be the next focus of his strategic plan before he was assassinated. The bottleneck is no longer in politics for us to gain true equality, but in the resources that we control.
Whether you are talking about business decisions, personal productivity, or societal issues, marginal thinking is key to making rational decisions about scarce resources. It clarifies our thinking because it reduces the scope of the problem and wipes away extraneous clutter, allowing us to focus on the task in front of us. Remember, a 3,000 mile walk begins with a single step.