Marginal analysis examines the costs and benefits of small incremental changes to determine the optimal level of a decision variable. It works by comparing the marginal benefit and marginal cost of an additional unit. If the marginal benefit exceeds the marginal cost, the decision variable should be increased as net benefits will rise. For example, a firm considers producing one more widget. If the extra widget's marginal revenue of $1,200 is less than its marginal cost of $1,500, the firm should not produce it, as net profits would fall. Marginal analysis provides a framework for maximizing benefits given scarce resources.

1. 1
Marginal AnalysisMarginal Analysis
A Key to Economic AnalysisA Key to Economic Analysis

2. 2
Marginal AnalysisMarginal Analysis
Marginal analysis is used to assistMarginal analysis is used to assist
people in allocating their scarcepeople in allocating their scarce
resources to maximize the benefit ofresources to maximize the benefit of
the output produced.the output produced.
Simply getting the most value for theSimply getting the most value for the
resources used.resources used.

3. 3
Marginal AnalysisMarginal Analysis
Marginal analysis: The analysis of theMarginal analysis: The analysis of the
benefits and costs of the marginal unitbenefits and costs of the marginal unit
of a good or input.of a good or input.
(Marginal = the next unit)(Marginal = the next unit)

4. 4
Marginal AnalysisMarginal Analysis
A technique widely used in businessA technique widely used in business
decision-making and ties together muchdecision-making and ties together much
of economic thought.of economic thought.
In any situation, people want toIn any situation, people want to
maximize net benefits:maximize net benefits:
Net Benefits = Total Benefits - TotalNet Benefits = Total Benefits - Total
CostsCosts

5. 5
The Control VariableThe Control Variable
To do marginal analysis, we can change aTo do marginal analysis, we can change a
variable, such as the:variable, such as the:
quantity of a good you buy,quantity of a good you buy,
the quantity of output you produce, orthe quantity of output you produce, or
the quantity of an input you use.the quantity of an input you use.
This variable is called theThis variable is called the control variable .control variable .

6. 6
The Control VariableThe Control Variable
Marginal analysis focuses upon whetherMarginal analysis focuses upon whether
the control variable should bethe control variable should be
increased by one more unit or not.increased by one more unit or not.

7. 7
Key Procedure for UsingKey Procedure for Using
Marginal AnalysisMarginal Analysis
1. Identify the control variable (cv).1. Identify the control variable (cv).
2.2. Determine what the increase in totalDetermine what the increase in total
benefits would be if one more unit ofbenefits would be if one more unit of
the control variable were added.the control variable were added.
This is theThis is the marginal benefitmarginal benefit of theof the
added unit.added unit.

8. 8
Key Procedure for UsingKey Procedure for Using
Marginal AnalysisMarginal Analysis
3.3. Determine what the increase in totalDetermine what the increase in total
cost would be if one more unit of thecost would be if one more unit of the
control variable were added.control variable were added.
This is theThis is the marginal costmarginal cost of the addedof the added
unit.unit.

9. 9
Key Procedure for UsingKey Procedure for Using
Marginal AnalysisMarginal Analysis
4.4. If the unit's marginal benefit exceedsIf the unit's marginal benefit exceeds
(or equals) its marginal cost, it should(or equals) its marginal cost, it should
be added.be added.

10. 10
Key Procedure for UsingKey Procedure for Using
Marginal AnalysisMarginal Analysis
Remember to look only at the changesRemember to look only at the changes
in total benefits and total costs.in total benefits and total costs.
If a particular cost or benefit does notIf a particular cost or benefit does not
change,change, IGNORE IT !IGNORE IT !

11. 11
Why Does This Work?Why Does This Work?
Because:Because:
Marginal Benefit = Increase in Total BenefitsMarginal Benefit = Increase in Total Benefits
per unit of controlper unit of control
variablevariable
∆∆ TR /TR / ∆∆ QQcvcv == MRMR
where cv = control variablewhere cv = control variable

12. 12
Why Does This Work?Why Does This Work?
Marginal Cost = Increase in Total CostsMarginal Cost = Increase in Total Costs
per unit of controlper unit of control
variablevariable
∆∆ TC /TC / ∆∆ QQcvcv == MCMC

13. 13
Why Does This Work?Why Does This Work?
So:So:
Change in Net Benefits =Change in Net Benefits =
Marginal Benefit -Marginal Benefit - Marginal CostMarginal Cost

14. 14
Why Does This Work?Why Does This Work?
When marginal benefits exceedWhen marginal benefits exceed
marginal cost, net benefits go up.marginal cost, net benefits go up.
So the marginal unit of the controlSo the marginal unit of the control
variable should be added.variable should be added.

15. 15
Example: Should a firm produceExample: Should a firm produce
more ?more ?
A firm's net benefit of being in business isA firm's net benefit of being in business is
PROFIT.PROFIT.
The following equation calculates profit:The following equation calculates profit:
PROFIT = TOTAL REVENUE - TOTALPROFIT = TOTAL REVENUE - TOTAL
COSTCOST

16. 16
Example: Should a firm produceExample: Should a firm produce
more ?more ?
Where:Where:
TR = (PTR = (Poutputoutput X QX Qoutputoutput))
nn
TC =TC = ΣΣ (P(Pinputinputii
X QX Qinputinputii
))
i=1i=1
Assume the firm's control variable is theAssume the firm's control variable is the
output it produces.output it produces.

17. 17
Problem:Problem:
International Widget is producing fiftyInternational Widget is producing fifty
widgets at a total cost of $50,000 and iswidgets at a total cost of $50,000 and is
selling them for $1,200 each for a totalselling them for $1,200 each for a total
revenue of $60,000.revenue of $60,000.
If it produces a fifty-first widget, itsIf it produces a fifty-first widget, its
total revenue will be $61,200 and itstotal revenue will be $61,200 and its
total cost will be $51,500.total cost will be $51,500.

18. 18
Problem:Problem:
Should the firm produce the fifty-firstShould the firm produce the fifty-first
widget?widget?

19. 19
Answer: NOAnswer: NO
The fifty-first widget's marginal benefitThe fifty-first widget's marginal benefit
is $1,200is $1,200
($61,200 - $60,000) / 1($61,200 - $60,000) / 1
This is the change in total revenue fromThis is the change in total revenue from
producing one additional widget andproducing one additional widget and
is called marginal revenue.is called marginal revenue.

20. 20
Answer:Answer:
The firm's marginal cost is $1,500The firm's marginal cost is $1,500
($51,500 - $50,000) / 1($51,500 - $50,000) / 1
This is the change in total cost fromThis is the change in total cost from
producing one additional widget.producing one additional widget.
This extra widget shouldThis extra widget should NOTNOT bebe
produced because it does not add toproduced because it does not add to
profit:profit:

21. 21
Answer:Answer:
Change in Net Revenue (Benefit) =Change in Net Revenue (Benefit) =
Marginal Revenue - Marginal CostMarginal Revenue - Marginal Cost
- $300- $300 = $1,200 - $1,500= $1,200 - $1,500

22. 22
∆∆QQcvcv QQwidgetswidgets TRTR ∆∆TRTR TCTC ∆∆TCTC
50 60,000 50,00050 60,000 50,000
11 1,200 1,5001,200 1,500
51 61,200 51,50051 61,200 51,500
MR =MR = ∆∆ TR /TR / ∆∆ QQcvcv == $1,200 / 1 = $1,200$1,200 / 1 = $1,200
MC =MC = ∆∆ TC /TC / ∆∆ QQcvcv == $1,500 / 1 = $1,500$1,500 / 1 = $1,500

23. 23
A Question:A Question:
What is the minimum price consumersWhat is the minimum price consumers
would have to pay to get a 51st Widgetwould have to pay to get a 51st Widget
produced?produced?
Consumers would have to pay at leastConsumers would have to pay at least
$1,500 for the extra widget to get the$1,500 for the extra widget to get the
producer to increase production.producer to increase production.

24. 24
SummarySummary
Marginal analysis forms the basis ofMarginal analysis forms the basis of
economic reasoning.economic reasoning.
To aid in decision-making, marginalTo aid in decision-making, marginal
analysis looks at the effects of a small changeanalysis looks at the effects of a small change
in the control variable.in the control variable.

25. 25
SummarySummary
Each small change produces someEach small change produces some
good (its marginal benefit) and somegood (its marginal benefit) and some
bad (its marginal cost).bad (its marginal cost).
As long as there is more "good" thanAs long as there is more "good" than
"bad", the control variable should be"bad", the control variable should be
increased (since net benefits will thenincreased (since net benefits will then
be increased).be increased).

26. 26
Practical Exercise:Practical Exercise:
Turn to the class exercise in yourTurn to the class exercise in your
Notebooks.Notebooks.
Please complete the class exercise.Please complete the class exercise.