Missing the margin: behavioral biases in incremental decision making

Understanding the difference between average and marginal effects is an essential element of effective decision making. Yet economists find that consumers often misperceive gains or costs at the margin in all but the simplest environments. This paper presents an experiment based on incremental production decisions, intended to evaluate marginal thinking and psychological biases like “melioration” that result from comparisons of averages. The structures of the production functions for alternative products (“Green Eggs” and “Ham”) are not explicitly provided and are revealed as financially motivated subjects make labor input allocation choices in a sequence of rounds with increasing numbers of workers to be assigned. Despite some learning, the authors find that only about a quarter of subjects make the optimal allocation in the final rounds. Subjects tend to over allocate workers to the production process with higher average products, especially in early rounds. A second treatment holds the optimal worker allocation constant but sharpens marginal incentives, which does not alleviate the apparent attraction provided by differences in average products.