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Marginal Analysis Notes

Marginal analysis is used to maximize the benefits from scarce resources by analyzing the costs and benefits of producing one additional unit. It focuses on whether the control variable, such as quantity produced, should be increased by comparing the marginal benefit and marginal cost. If the marginal benefit exceeds the marginal cost, the additional unit should be produced to increase net benefits. For example, a firm should not produce a 51st widget if the marginal cost of $1,500 exceeds the marginal benefit of $1,200.

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Vikram Mandal
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294 views

Marginal Analysis Notes

Marginal analysis is used to maximize the benefits from scarce resources by analyzing the costs and benefits of producing one additional unit. It focuses on whether the control variable, such as quantity produced, should be increased by comparing the marginal benefit and marginal cost. If the marginal benefit exceeds the marginal cost, the additional unit should be produced to increase net benefits. For example, a firm should not produce a 51st widget if the marginal cost of $1,500 exceeds the marginal benefit of $1,200.

Uploaded by

Vikram Mandal
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Marginal Analysis

A Key to Economic Analysis

1
Marginal Analysis

Marginal analysis is used to assist


people in allocating their scarce
resources to maximize the benefit of
the output produced.

Simply getting the most value for the


resources used.

2
Marginal Analysis

Marginal analysis: The analysis of the


benefits and costs of the marginal unit
of a good or input.

(Marginal = the next unit)

3
Marginal Analysis

A technique widely used in business


decision-making and ties together much
of economic thought.

In any situation, people want to maximize


net benefits:
Net Benefits = Total Benefits - Total Costs

4
The Control Variable

To do marginal analysis, we can change a


variable, such as the:

 quantity of a good you buy,


 the quantity of output you produce, or
 the quantity of an input you use.

This variable is called the control variable .


5
The Control Variable

Marginal analysis focuses upon whether


the control variable should be
increased by one more unit or not.

6
Key Procedure for Using
Marginal Analysis
1. Identify the control variable (cv).

2. Determine what the increase in total


benefits would be if one more unit of
the control variable were added.

This is the marginal benefit of the


added unit.
7
Key Procedure for Using
Marginal Analysis
3. Determine what the increase in total
cost would be if one more unit of the
control variable were added.

This is the marginal cost of the added


unit.

8
Key Procedure for Using
Marginal Analysis
4. If the unit's marginal benefit exceeds
(or equals) its marginal cost, it should
be added.

9
Key Procedure for Using
Marginal Analysis
Remember to look only at the changes in
total benefits and total costs.

If a particular cost or benefit does not


change, IGNORE IT !

10
Why Does This Work?

Because:

Marginal Benefit = Increase in Total Benefits


per unit of control
variable
TR / Qcv = MR
where cv = control variable
11
Why Does This Work?

Marginal Cost = Increase in Total Costs


per unit of control
variable

TC / Qcv = MC

12
Why Does This Work?

So:

Change in Net Benefits =

Marginal Benefit - Marginal Cost

13
Why Does This Work?

When marginal benefits exceed


marginal cost, net benefits go up.

So the marginal unit of the control


variable should be added.

14
Example: Should a firm produce
more ?
A firm's net benefit of being in business is
PROFIT.
The following equation calculates profit:

PROFIT = TOTAL REVENUE - TOTAL


COST

15
Example: Should a firm produce
more ?
Where:

TR = (Poutput X Qoutput)
n

TC =  (Pinputi X Qinputi)
i=1

Assume the firm's control variable is the


output it produces. 16
Problem:

International Widget is producing fifty


widgets at a total cost of $50,000 and is
selling them for $1,200 each for a total
revenue of $60,000.

If it produces a fifty-first widget, its total


revenue will be $61,200 and its total
cost will be $51,500.
17
Problem:

Should the firm produce the fifty-first


widget?

18
Answer: NO

The fifty-first widget's marginal benefit is


$1,200

($61,200 - $60,000) / 1

This is the change in total revenue from


producing one additional widget and is
called marginal revenue.
19
Answer:

The firm's marginal cost is $1,500


($51,500 - $50,000) / 1
This is the change in total cost from
producing one additional widget.

This extra widget should NOT be produced


because it does not add to profit:

20
Answer:

Change in Net Revenue (Benefit) =

Marginal Revenue - Marginal Cost

- $300 = $1,200 - $1,500

21
Qcv Qwidgets TR TR TC TC

50 60,000 50,000
1 1,200 1,500
51 61,200 51,500

MR = TR / Qcv = $1,200 / 1 = $1,200


MC = TC / Qcv = $1,500 / 1 = $1,500
22
A Question:

What is the minimum price consumers


would have to pay to get a 51st Widget
produced?

 Consumers would have to pay at least


$1,500 for the extra widget to get the
producer to increase production.

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Summary

 Marginal analysis forms the basis of economic


reasoning.

 To aid in decision-making, marginal analysis


looks at the effects of a small change in the
control variable.

24
Summary

 Each small change produces some good


(its marginal benefit) and some bad (its
marginal cost).

 As long as there is more "good" than


"bad", the control variable should be
increased (since net benefits will then
be increased).
25
Practical Exercise:

Turn to the class exercise in your


Notebooks.

Please complete the class exercise.

26

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