Marginal analysis
Marginal analysis is a financial technique used in accounting and economics to evaluate the implications of incremental changes in decision-making, particularly in relation to production and employment. It focuses on assessing the costs and benefits associated with the next unit of a particular activity, such as hiring an additional employee or producing one more product. This method allows companies to identify the most efficient ways to maximize profits while minimizing costs. Pioneered by Alfred Marshall, marginal analysis integrates key economic concepts like supply and demand and the costs of production.
Businesses often use marginal analysis to determine whether the positive outcomes of a decision, such as increased profits, outweigh the negative consequences, such as additional costs. Beyond corporate applications, this analysis is also relevant for consumers, as it helps to understand how the utility gained from purchasing additional goods changes as consumption increases. The law of diminishing marginal utility explains that the satisfaction derived from additional units usually declines over time. Overall, marginal analysis serves as a vital tool for decision-makers across various fields, aiding in the quest for optimal efficiency and profitability.
On this Page
Subject Terms
Marginal analysis
Marginal analysis is a technique in accounting often used by financial analysts to study the activities of a company or consumer. Specifically, marginal analysis examines the positives and negatives involved in the next unit of a particular series. This unit might be an additional worker being hired, or an additional product being produced, bought, or sold. Companies usually use marginal analysis techniques to find the best balance of employment and production that generates the highest profit.
Overview
Most companies seek to generate a profit. Many employ financial analysts to study the workings of the company—its leadership, policies, and financial figures—to determine whether the profit is as high as it can be, and whether it is being generated by the most efficient means. Even a company that is generating a large profit may be highly inefficient, and may benefit from new policies that increase its efficiency.
One of the main concepts in analyzing business efficiency is the margin. In economics, the concept of margins relates to the effect of the next unit in a particular series. This effect may be a positive (a marginal benefit) or a negative (a marginal cost). The unit may also take a wide variety of forms, but often relates to another product that may be produced, bought, or sold, or another employee who may be hired, not hired, or released.
Marginal analysis is the main tool that financial analysts use to determine how a company should manage the next unit in a given series. Analysts seek to promote decisions that will maximize profits and other benefits, while minimizing costs. For example, a company may employ marginal analysis to decide whether hiring another worker would create more profits than costs, or whether producing an extra item each day would create more income than the costs of producing that extra item.
Companies and decision-makers in all fields may find marginal analysis extremely useful. However, it is not the sole method of determining the effectiveness of a decision. For example, analysts must also consider opportunity cost, a situation in which a decision yields less profit than a different decision would have. For example, marginal analysis might indicate that a company would profit by using $50,000 per year to hire another worker. However, further analysis might show that using that same money to create two new products per day would yield an even higher profit for the company.
Marginal analysis does not only apply to companies. Some aspects of the study also apply to consumers. A related concept is marginal utility, which relates to the benefit a consumer gains by purchasing and using an additional unit of a good or service. In most cases, marginal benefit declines as the number of purchases increases, due to the law of diminishing returns. For example, a consumer might buy a loaf of bread for $3. That bread will satisfy the consumer’s needs for a week, and the consumer will likely not buy another loaf for $3. However, the consumer may be enticed to buy a second loaf if it is on sale for $1.50. In this case, the marginal benefit of the second purchase is reduced by half.
Bibliography
"FAQ: What Is Marginal Analysis? (With Uses and Example)." Indeed, 4 Feb. 2023, www.indeed.com/career-advice/career-development/marginal-analysis. Accessed 28 Dec. 2024.
Fernando, Jason. “Opportunity Cost: Definition, Formula, and Examples.” Investopedia, 29 Aug. 2024, www.investopedia.com/terms/o/opportunitycost.asp. Accessed 28 Dec. 2024.
Hayes, Adam. “Marginal Analysis in Business and Microeconomics, with Examples.” Investopedia, 15 Apr. 2024, www.investopedia.com/terms/m/marginal-analysis.asp. Accessed 28 Dec. 2024.
Kenton, Will. "What Is a Marginal Benefit in Economics, and How Does It Work?" Investopedia, 4 Sept. 2024, www.investopedia.com/terms/m/marginalbenefit.asp. Accessed 28 Dec. 2024.
Lewis, Jared. “How to Make a Spending Decision with Marginal Analysis.” Houston Chronicle, smallbusiness.chron.com/make-spending-decision-marginal-analysis-38351.html. Accessed 28 Dec. 2024.
“Marginal Analysis.” Corporate Finance Institute, corporatefinanceinstitute.com/resources/economics/marginal-analysis. Accessed 28 Dec. 2024.
“Marginal Analysis.” Duffka School of Economics, www.duffka.com/basic-economic-concepts/marginal-analysis. Accessed 28 Dec. 2024.
"Marginal Analysis." Principle Based Management, www.principlebasedmanagement.com/en/principles-in-brief/marginal-analysis. Accessed 28 Dec. 2024.
Ross, Sean. "How Marginal Analysis Helps in Managerial Decisions." Investopedia, 31 July 2021, www.investopedia.com/ask/answers/042315/how-marginal-analysis-used-making-managerial-decision.asp. Accessed 28 Dec. 2024.