Marginal Analysis

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What is 'Marginal Analysis'

Marginal analysis is an examination of the additional benefits of an activity compared to the additional costs incurred by that same activity. Companies use marginal analysis as a decision-making tool to help them maximize their potential profits. Individuals unconsciously use marginal analysis as well, to make a host of everyday decisions.

BREAKING DOWN 'Marginal Analysis'

Marginal analysis is also widely used in microeconomics when analyzing how a complex system is affected by marginal manipulation of its comprising variables. In this sense, marginal analysis focuses on examining the results of small changes as the effects cascade across the business as a whole.

Marginal analysis is an examination of the associated costs and potential benefits of specific business activities or financial decisions. The goal is to determine if the costs associated with the change in activity will result in a benefit that is sufficient enough to offset them. Instead of focusing on business output as a whole, the impact on the cost of producing an individual unit is most often observed as a point of comparison.

Example of Marginal Analysis in the Manufacturing Field

When a manufacturer wishes to expand its operations, either by adding new product lines or increasing the volume of goods produced from the current product line, a marginal analysis of the costs and benefits is necessary. Some of the costs to be examined include, but are not limited to, the cost of additional manufacturing equipment, any additional employees needed to support an increase in output, large facilities for manufacturing or storage of completed products, and as the cost of additional raw materials to produce the goods.

Once all of the costs are identified and estimated, these amounts are compared to the estimated increase in sales attributed to the additional production. This analysis takes the estimated increase in income and subtracts the estimated increase in costs. If the increase in income outweighs the increase in cost, the expansion may be a wise investment.

Comparing Multiple Options

Marginal analysis can also help in the decision-making process when two potential investments exist, but there are only enough available funds for one. By analyzing the associated costs and estimated benefits, it can be determined if one option will result in higher profits than another.

Marginal Analysis and Observed Change

From a microeconomic standpoint, marginal analysis can also relate to observing the effects of small changes within standard operating procedure or total outputs. For example, a business may attempt to increase output by 1% and analyze the positive and negative effects that occur because of the change, such as changes in overall product quality or how the change impacts the use of resources. If the results of the change are positive, the business may choose to raise production by 1% again, and reexamine the results. These small shifts, and the associated changes, can help a production facility determine an optimal production rate.

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