Rational Degens Think At The Margin

There are four principles that Gregory Mankiw outlines in his multi-disciplinary economics textbook Principles of Economics. 

These four principles are:

  1. People Face Trade-Offs

  2. The Cost of Something Is What You Give Up to Get It

  3. Rational People Think At The Margin, and

  4. People Respond To Incentives

The third law is what I want to break down right now...

Here's Mankiw: "Rational people systematically and purposefully do the best they can to achieve their objectives, given the available opportunities." 

Rationality is the recognition and acceptance of facts. If you're going to be a capable skeptic and thinker, you need to obey the facts. This distinguishes rationality from irrationality: rationality obeys reality; irrationality obeys authority, dogma, or wishful thinking.

Marginal thinking is a mindset that assesses how much you value something extra. You disregard past investments in what is currently taking place, and you weigh the benefits and drawbacks of purchasing another NFT.

The rational choice theory says that people act to maximize their satisfaction or utility. Rationality has nothing directly to do with 'right' and 'wrong'; it's a matter of personal observation and inferrance based on potential marginal gains. Rationality is an approximation, a rule of thumb that gets us closer to the truth when we don't know what would be the best course in a given situation or if we can't figure out exactly how to achieve our ends.

Mankiw suggests that the rational person is unaffected by sunk costs - the weight of the investments you have already made and the NFTs you have purchased - so you do not consider them when making decisions at the margin.

In NFT investment and collecting, marginal thinking is what encourages buyers who consider themselves to be rational thinkers to continue making marginal investments in a key property, based on the potential upside each token represents, even as the price of that project (and its tokens) fall, in line with their perception of its utility and anticipated value, measured against the marginal cost of investing more currency into the property.

I would argue that for NFTs, the only real marginal considerations are capital investment and opportunity. There is no 'right' or 'wrong' to any property's token price, as the value of each token representing a project is subjectively determined by its potential utility in relation to other projects. In the case of a successful project, any increase in price is directly aligned with its utility. In this model, investment is not risk-based as much as it is reward-based.

The rational thinker looks to the bottom line, not the top, seeing beyond what is visible to create growth or revenue.

The rationality idea is essential in finance because it underpins economic theory and helps to make decisions on investments.

Marginal thinking is about considering a small step beyond your current position and evaluating what would happen if you took it. We tend to compare how we're doing now with our previous status and then work out how far we can go before reaching diminishing returns: our marginal gains.

We use marginal thinking daily to determine if it's worth trading or buying more NFTs. For instance, you might calculate that the earning prospects of your second Mutant Cat are more significant than your third at this time, so you refrain from purchasing a third and instead buy or mint an alternative. You might also make the opposite decision.

Every piece of information you learn changes your decision-making process by some small percentage.

So, marginal thinking can help you decide between two competing perspectives or approaches based on incremental information rather than proceeding with one attitude toward something.

Diminishing Marginal Utility

The Law of Diminishing Marginal Utility is an economic law that states as you consume more and more of something, the less value each additional unit has.

For example: if you eat a bag of Doritos, assuming they're not Mountain Dew or Cool Ranch or some other Godless flavor, the first three chips are good. The fourth chip is still reasonably tasty. By chip twenty-eight, you're just barely tasting anything at all.

Whether it's Doritos or hour after hour of labor or one more NFT, your performance, enjoyment, and perceived benefit start to decrease as you do more of something.

While the Law of Diminishing Marginal Utility is widely applicable, it doesn't mean that you'd never want more of something. If you buy one NFT token, do you need to buy another? Probably not, but if you see an opportunity for profit or to diversify your collection based on future use cases of the game world. But these opportunities won't remain static. There are always different NFTs coming out, changing the calculation, movements in the tech space that orients it - EG, coinbase announcements, etc. - and trends in public perception.

We are left with 3 questions, though:

  1. Is marginal thinking always rational?

  2. If you consider yourself rational, does that mean your decisions reflect the decisions of a rational group?

  3. Are any of us JPEG buying weirdos rational in any way?

Colloquially using the term rationality to mean something along the lines of 'good decision making process' is a slippery slope. The criteria for what makes a good decision are deeply personal. When we say someone's decisions are rational, it can be misinterpreted as meaning it was an objectively good decision. It ain't that easy.

Economists use the term rational in a way that is much more structured than the common usage. The Economic Rationalist school of thought arose after WWII and has since dominated mainstream economics. At its heart, it states that people are rational when they act in their self-interest to maximize satisfaction or utility.

Marginal thinking is grounded in this concept, and it helps us make sense of the world around us. But because marginal thinking is a means to an end, not the end itself, we must remain vigilant for instances where it fails to be rational.