The arithmetic of efficiency—Or the value of marginal analysis

This teaching note focuses on two common difficulties for students. The first is the failure to think in terms of marginal effects. Deciding whether something is worthwhile depends upon what other options are available. When confronted with a program that costs more than another but also has greater effects, students often don’t realize that they need to examine the marginal cost per marginal effect of the more expensive program relative to the other program. The second, related, difficulty is not realizing that, unless you have a value to place on the effects, you generally can’t say whether a project is worthwhile. Instead, students see that buying only one unit may provide a lower cost per unit than buying more units (assuming declining marginal effectiveness). Then they label that the most “cost-effective†option, and proceed to recommend that it be adopted. Several variations related to cost-effectiveness are discussed.