What is Marginal Analysis?
Definition: Marginal analysis refers to the examination of costs and benefits upon the introduction of a new unit of production. The analysis comes into play when businesses want to ascertain whether they are getting the most value out of resources. Conversely, businesses must ensure that changes in the production process result in benefits that outweigh the total costs for high levels of profitability.
Marginal analysis is therefore used as a decision-making tool as businesses seek to maximize their potential profits by carrying out changes in the production process. Amidst the examination, the focus is usually on costs and benefits.
In macroeconomics, marginal analysis allows managers to understand how manipulation of various production variables might end up influencing a complex system. The analysis helps provide a clear understanding of whether changes in costs associated with activity might result in sufficient benefits. In this case, the focus is usually on the costs and benefits rather than the overall output.
Marginal Analysis Example
Consider airline XYZ that charges $650 for airline tickets between the London and Los Angeles route. The total cost of operating a 350-passenger Boeing 777 plane is $170,000. Upon conducting a marginal analysis, the airline ascertains that the airline moves between the two cities with several vacant seats.
In a bid to ensure maximum ticket sales, airline XYZ decides to offer last-minute tickets at $375 and ends up making a profit of $250 per passenger, given that the cost of transporting one passenger is $125.
Upon carrying out an analysis of total cost per ticket,which is ($170,000/350=$486)it is clear that the airline had overpriced its tickets on pricing them at $650 rather than $486. Therefore, the airline would have known in advance that it would have made substantial profits on selling tickets at $486 or less instead of $650 at the start.
Marginal Analysis Applications
Marginal analysis examination is often used in capital expenditure decisions. In this case, a business can increase its capital as long the marginal efficiency of capital exceeds the interest rate.
Likewise, marginal analysis finds great use when business are faced with the decision of investing capital to buy equipment to produce goods. While also faced with the option of having the goods produced by third parties instead of investing in specialized equipment, a business might have to carry such marginal analysis to ascertain which option is cost-effective.
The analysis will, in this case, try to ascertain the costs that the business is likely to incur as well as the benefits it is likely to accrue. By weighing the two, the business would be able to make an informed decision on what is likely to lead to increased profitability.
The marginal analysis also plays an important role when firms want to make output expansion and contraction decisions. While a company meets its equilibrium when marginal revenue equals marginal cost, it will not be able to increase its output, as long marginal cost is higher than marginal revenue.
Similarly, a firm is likely to continue adding products in its product line when marginal cost is lower than marginal revenue. The choice of an optimum product mix would also depend on the contribution that each product makes.
Why Marginal Analysis is Important?
Marginal analysis is paramount as it enables business owners and managers to know in advance whether producing one more unit is worth it. The analysis makes it possible to know whether additional revenue because of increased production will exceed costs leading to increased profitability.
The marginal analysis also helps customers know whether buying one extra unit would lead to more satisfaction and exceed the overall cost. In this case, if the benefits exceed the costs, then something must be worth it.
Likewise, businesses can leverage marginal analysis to ascertain how marginal revenues measure up against the marginal cost. Production decisions are consequently made based on the outcome of margin analysis.