Lesson 1 - Financial Planning - Part 9

Making Financial Decisions

Marginal Analysis

To conduct the second important test we need to be looking at changes in important variables that are related to changes in decisions you can control.  Let’s say for example you are at a fair and there is a lot of food available to you.  After many choices you decide that pizza will fit your goals the best.  After two slices of pizza, you might see a third slice as too much.  To decide if you should buy the third slice of pizza requires that you again compare the benefits of a third slice against the cost.  If you think the added slice is worth the cost then buy the third slice; if not then don’t buy the third slice.  Remember that the benefits provided by the first two slices of pizza don’t matter in this situation.

You have already consumed the first two, and a third will not bring the same amount of benefit the first two had.  Whenever we have a decision to make that involves comparing Choices, you should be using a Marginal Analysis also.  A better example is when you are comparing your choices for car insurance.  Plan A offers protection against certain perils while plan B does not.  Plan A also requires a higher premium (more money).  In order for us to make a decision, we only need to look at and compare the extra (marginal) coverage with the extra (marginal) premium.  Then decide if the more comprehensive policy is worth the extra cost.