Marginal Analysis, Roller Coasters, Elasticity, and Van Gogh: Crash Course Econ #18
Marginal benefit vs. marginal cost
The difference you experience when you make a different decision is known as a marginal benefit. In the world of business, this is typically the extra money the business makes when it increases production and/or sells more goods. The additional cost you pay when you produce more units of a product is known as the marginal cost. Marginal costs typically decrease as a business produces an increasing volume of goods.
What is marginal analysis?
Marginal analysis is the study of the expenses and advantages of particular actions. When a company reaches the break-even point, where its production costs are equal to its revenue, marginal analysis can show the cost of additional production.
Businesses use marginal analysis to make sure the advantages of particular activities outweigh the disadvantages. For instance, if a business is thinking about increasing the volume of goods it produces, it will conduct a marginal analysis to make sure the cost of producing more products outweighs the additional costs that will come along with that decision, such as an increase in labor costs or additional materials you might need to manufacture the goods. Decision-makers can use marginal analysis to determine how to allocate resources to maximize profits and benefits and reduce costs.
Marginal analysis and observed change
In some circumstances, it may be sensible for a business to make minor operational adjustments before following up with a marginal analysis to examine the changes in costs and benefits that transpired as a result of those adjustments. For instance, a manufacturer of children’s toys might decide to increase production by 1% to observe any changes in quality and the effects on resources.
The managers may decide to maintain the higher production rate or even raise production by 1% again to track any changes that take place if they determine that the advantages of an increase in production outweigh any additional costs the company faces. Companies can determine the best production rates by making minor adjustments and monitoring the results.
Marginal analysis and opportunity cost
You must comprehend opportunity cost in addition to cost and benefit in order to fully comprehend some activities. A valuable benefit that you forego by selecting one option over another is known as an opportunity cost. For instance, if a business is considering hiring a second worker for a factory and has room in its budget for it, a marginal analysis shows that doing so would provide a net marginal benefit. To put it another way, the capacity to produce more goods outweighs the rise in labor costs. Even so, employing that person might not be the best move for the business.
For instance, if the business determines that adding a sales representative could result in a higher net marginal benefit, hiring a salesperson as opposed to someone to work in the factory is the best course of action. The opportunity cost is the increased productivity that the business would have gained by hiring a worker for the factory.
Marginal analysis and variables
Cost and production factors must be taken into account when using marginal analysis to make decisions. The most frequent factor that businesses consider is the quantity of the products you are producing. However, there are some costs, like shipping, that go up as you produce and distribute more or heavier products. You can select from a variety of production levels with varying levels of profitability by making gradual changes to production and keeping an eye on the advantages and costs that go along with those changes.
Example of marginal analysis
Management may decide to conduct a marginal analysis if a company is considering growing to produce more products in order to assess whether the additional costs the company will incur are a wise investment in the expansion of the business. Management will first need to add all of the additional costs linked to an increase in production in order to accomplish this. For instance, they might need to spend more money on equipment to produce more goods, hire more people to work in the factory, which will cost more in salaries and benefits, and buy more materials to produce more products. In order to store the additional goods before they are distributed and sold, they might also need to rent or buy extra warehouse space.
The managers can then determine the additional income they can anticipate after estimating the total costs associated with the decision to expand company operations. Management can then determine whether the increase in income outweighs the increase in cost by deducting all expenses from the income of more sales.
Let’s use a straightforward example where a t-shirt manufacturer is debating whether to increase production. Every shirt they manufacture requires $0. 80 of fabric. The t-shirt company has $200 of fixed costs per month. If you produce 100 shirts per month, each one costs $2. 00 of those fixed costs. That means that the total cost per shirt is $2. 80. The fixed cost of each shirt would fall to $1 if the business chose to increase production to 200 shirts per month. 00. The total cost of the shirt, then, is $1. 80, as the cost of materials remains the same. In this scenario, doubling production significantly lowers marginal costs.
FAQ
What is marginal analysis?
What Is Marginal Analysis? Marginal analysis is the study of the additional benefits of a course of action in comparison to the additional expenses that course of action will result in. When making decisions, businesses use marginal analysis to maximize their potential profits.
What is marginal analysis formula?
Using the formula change in net benefits = marginal benefits – marginal cost, marginal analysis seeks to ascertain the change in net benefits. The increase in total benefits brought on by a one-unit change in a good’s output is known as a marginal benefit.
Why is marginal analysis important in economics?
Often, business growth decisions are based on increasing profit. Marginal analysis aids in segmenting these choices into smaller units for easier comprehension and improved performance.
