Marginal Benefit vs. Marginal Cost: An Overview
Marginal benefit and marginal cost are two measures of how the cost or value of product changes. While one is a measurement from the consumer side of the equation, the other is a measurement from the producer side. Companies need to take both concepts into consideration when manufacturing, pricing, and marketing a product.
A marginal benefit is a small, but measurable, change in a consumer's advantage if they use an additional unit of a good or a service.
Marginal benefit usually declines as a consumer decides to consume more and more of a single good. For example, imagine a consumer decides that she needs a new piece of jewelry for her right hand, and she heads to the mall to purchase a ring. She spends $100 for the perfect ring, and then she spots another. Since she does not need two rings, she would be unwilling to spend another $100 on a second one. She might, however, be convinced to purchase that second ring at $50. Therefore, her marginal benefit reduces from $100 to $50 from the first to the second good.
Another way to think of marginal benefit is to consider the satisfaction that a consumer gets from each subsequent addition. One ring would make the consumer very happy, while a second ring would still make her happy, just not as much. The lessening of appeal for additional consumption is known as diminishing marginal utility.
Marginal benefit is often expressed as the dollar amount the consumer is willing to pay for each purchase. It is the motivation behind such deals offered by stores as with "buy one, get one-half off" promotions.
Prescription drugs and necessities such as electricity are goods and services that are not subject to the effect of marginal benefits.
On the opposite side of the equation lies the producer of the good or service. Producers consider marginal cost which is the small but measurable change in the expense to the business if they produce one additional unit.
If a company has captured economies of scale, the cost to produce a product declines as the company produces more and more of it. For example, imagine a company is making shoes. Each shoe requires $5 worth of leather, rubber, thread, and other materials to create. The shoes also require a factory, which, for simplicity sake, let us say is a one-time $1,000 expense. If the company makes 100 shoes, each shoe costs $15 to make ($1,000/100+$5).
The workers learn how to move from one task to the next quickly, and the factory can produce more shoes per hour. As more footwear is made in the same specified period, the cost of the factory is further distributed over more shoes, and their cost per unit falls. Also, the cost of materials could go down, as well, as more shoes are made and the materials are purchased in bulk, decreasing the marginal cost.
The cost benefit from this approach has a ceiling, however. Buying materials in bulk can only push the price down so far, and production in a factory can only go up so far before machines and workers are exhausted, meaning a new factory must be built or new workers hired. Building a new factory is only profitable if the consumer demand for the new product, the marginal benefit of which may have decreased through overproduction.
- Marginal benefits are the maximum amount a consumer will pay for an additional good or service.
- The marginal benefit generally decreases as consumption increases.
- The marginal cost of production is the change in cost that comes from making more of something.
- The purpose of analyzing marginal cost is to determine at what point an organization can achieve economies of scale.