Marginal analysis is an essential tool in marketing to decide the next step in the market. It helps the managerial heads to choose for any new investment to an activity or thing. It is an excellent way to study if the cost is worth incurring for the extra profit.
For example, if a company decides to employ 50 new staff, they will do the marginal analysis for the year-end that increment of production will be worth bearing the cost due to this additional cost of employing new staff.
So, all in all, marginal analysis is the evaluation of the costs and benefits of a minimal change in an organisation for conducting some additional activities such as goods production, the inclusion of other units, etc.
In this post, we will explore the concepts associated with Marginal Analysis, and understand how important it is for businesses in making profitable economic decisions. So, let us get started right away-
What is Marginal Analysis?
When we hear the word “Marginal Analysis” the first thing that comes in our mind is that it has something to do with the marginal values. So before learning more about it, let’s know what Marginal Analysis us.
It is a cost-benefit analysis for a new activity. It is a tool used by most of the companies to increase their profit. Here the company heads compare the marginal benefit acquired by action or business step along with the minimal cost incurred in the activity.
It helps in deciding whether the additional benefit is worth the extra costs and resources incurred to the new plan. Managers use this as a profit maximization tool by comparing the value and benefit of marginal change.
In simpler words, the marginal analysis estimates how the production volume of a business can affect its operations, status and profits.
Why is Marginal Analysis essential for any Company?
Everyone wants to get as much profit as possible out of as little cost as possible.
And marginal analysis makes it easier for the companies to compare the cost-benefit minimal values to get the best out of any investment.
So here are some points why marginal analysis is essential for any company.
- Marginal analysis is vital for the companies to decide whether to increase their business by increasing the amount of production of their goods or decreasing work power.
- It helps in product line management by assisting the company in deciding which product to drop and which one to keep producing additional for increasing the profits.
- It helps in the profit maximization by comparing the marginal benefit with the negligible cost amount.
- It helps any institutions to determine if they want to spend on their marginal expenditure of capital. Usually, a company stops adding to their stocks as soon as the rate of interest is equal to the capital expenditures.
- If you are buying some new widgets in the company, you can use the marginal analysis to compare the benefit of the machine with its cost.
How do you use Marginal Analysis?
Now, as we are well aware of what is marginal analysis. Here we will discuss some of the applications of this tool. Calculation of marginal analysis is based upon the change in the net benefit as per the following formula-
Net benefits = total benefits – total costs
Now, for implementing marginal analysis concept, you need to check how the benefits in the formula change while
- Purchasing, including or employing an additional unit
- Producing some extra units of your product or service
- Including an additional unit of any input
The additional input or output is considered as the control variable in calculating the marginal analysis. The marginal analysis mainly deals with whether the control variable should be changed to one or many.
Let us now learn the concept of Marginal Analysis, with its formula-
The formula for Calculating the Marginal Analysis
At first, the marginal benefit is measured by dividing the change in total gain by the change in quantity.
And the marginal cost is measured by dividing the change in total cost by the quantity.
In both the formulas-
MR – Marginal benefit
TR- Total Revenue
Q- Control Variable
MC- Marginal Cost
TC- Total Cost
d symbol- The change in units
Now, as we have the marginal benefit and marginal cost now, we can compare and do marginal analysis according to our needs.
A higher marginal benefit shows growth in a company, adding up to its stocks.
A lower marginal cost shows that the product needs to be dropped either or bought from outside.
And when the Marginal benefit is equal to marginal cost, it shows neither the growth of the company nor the loss. In this condition, the company is in equilibrium economically.
Where do you apply Marginal Analysis: Key Applications of Marginal Analysis
As we have learned about why the use of marginal analysis is essential and how can you apply it, it is time to get to know the final critical part about it. Where do you apply marginal analysis? Here are some points where it is described.
1) In deciding what to manufacture and what to buy
The marginal analysis helps the company to determine which commodity to buy from and which to make inside. If the minimal cost is higher in creating a product, then it is generally acquired from outside.
A product is made inside until the marginal benefit is higher than the marginal cost.
2) In making the right investment decisions
A business firm’s investment decisions are no child’s play. The marginal analysis helps to understand until when the business firm should keep investing in capital expenditure.
As long as the capital expenditure is higher than the rate of interest, the company will keep growing. Once the rate of interest is equal to the capital expenditures, it will not be able to add any more stock in it.
3) In analyzing how growth-oriented the company is
If you run a firm, you need to know if the firm is going or getting neutral. The firm keeps expanding until the marginal revenue, which is also called marginal benefit, is more excellent than minimal cost.
When these two becomes equal, the company can never grow irrespective of increasing or decreasing their sales volume.
4) In making decisions about the right products to manufacture and their numbers
It is an era where the companies have to keep changing their products regularly. The marginal analysis helps in choosing which product to drop and which one to follow. If the marginal benefit is more than the marginal cost of a product, it is kept, and if the marginal cost goes downer than the marginal benefit the product is dropped.
5) In deciding if running advertisements will be profitable or not
Advertising is a crucial part of product selling in modern days. And it costs quite a huge budget to advertise for a product. But it is hard to decide which product to advertise for, but it is made easier by applying marginal analysis.
You choose the product to announce until the marginal benefit is going higher than the marginal cost. Once the price is higher than the benefit, there is no use of advertisements anymore.
Disadvantages of Marginal Analysis
Marginal analysis has become the best tool to help the business organisation to utilize its human resources properly and provide its consumers, the best of everything they demand.
But as we know, there are always two sides to the story.
The same goes for here; there are also some disadvantages of Marginal Analysis. They are as follows:
- Marginal analysis has said to be the problematic concept of economics, and hence many economists have found it very difficult to explain. This is one of the most notable disadvantages of Marginal Analysis.
- Marginal analysis is useful for understanding the market of substitute goods and services, but it is not a clear concept for understanding the market and the demand of a consumer.
- Marginal analysis is a concept of assumption of a consumer’s demand. Therefore it is challenging to measure Marginal Analysis, as it is not applicable in the practical world most of the time.
- As Marginal Analysis analyses a situation or demand for certain goods in the foreseeable future, this can be a matter of regret later as the environment of business keeps changing every second, it is better now to stick to Marginal Analysis method.
- It can be seen that many a time Marginal Analysis also hampers a lot on the decisions of the company. It can also prove to be an expensive decision in the worst-case scenario. As the decision taken can be seen fruitful today but proves to be the wrong decision of tomorrow, then the company can suffer a considerable loss in that case.
How Marginal Analysis affects decisions?
The organisation is the sole body of decision-makers. Hence they have to make sure that their decisions are the best for the company and prove to be profitable for the future, as the sole motive of every organisation is to earn profit in the business world.
On the other hand, the Opportunity cost is the cost that is sacrificed when another alternative is chosen from the given a choice. The relationship of marginal cost and marginal analysis is that when marginal benefits decreases, marginal cost increases, and vice versa. The marginal analysis provides the optimal level of activity compared to marginal cost always.
In Marginal Analysis, the method can be proven significant to study the individual demand of the company as well as the group behavioral demand. Therefore many organisations adapt to Marginal Analysis for their Study. The measurements between Marginal Analysis and Marginal Cost give the company its cost-benefit results which show the company its cost and helps in maximization of profit.
Therefore, before making any decision, a company has to go through the proper Marginal cost and Marginal Analysis as they are interdependent.
It is also seen that Marginal cost can be a difficult one to study, as all the costs can be cited in one group. There are various costs in one cost like fixed cost, the variable cost, etc.; therefore, it becomes less challenging to come to a concluded cost for delivering the value of expenses for the company.
Hence, studying both can help the company to take a rational decision.
Marginal Analysis Wrap Up!
Marginal analysis has a huge part in deciding whether the company should look forward to a new activity or deal. Even the government bodies discuss the marginal analysis while allotting their resources for the schemes for the public good.
In private industry, also Marginal analysis has an essential role in checking and maximizing profit by analyzing cost-benefit.
We hope our article has helped you gain the information you needed about the Marginal Analysis and thank you for visiting us.
In case of any doubts and queries related to the exact implement of marginal analysis, feel free to ask us in the comments.