Loading the player...

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.

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.

RELATED TERMS
  1. Marginal Profit

    Marginal profit is the profit earned by a firm or individual ...
  2. Incremental Cost

    Incremental cost is the total change that a company experiences ...
  3. Initial Margin

    Initial margin is the percentage of the purchase price of securities ...
  4. Profitability Ratios

    Profitability ratios are a class of financial metrics that are ...
  5. Margin Pressure

    Businesses experience margin pressure when their operating profitability ...
  6. Marginal Cost Of Funds

    The marginal cost of funds includes the incremental increase ...
Related Articles
  1. Trading

    Margin Trading

    Find out what margin is, how margin calls work, the advantages of leverage and why using margin can be risky.
  2. Investing

    Finding Your Margin Investment Sweet Spot

    Borrowing to increase profits isn't for the faint of heart, but margin trading can mean big returns.
  3. Investing

    Profitability Indicator Ratios

    Learn about profit margin analysis, effective tax rate, return on assets, return on equity and return on capital employed.
  4. Investing

    Key Financial Ratios for Manufacturing Companies

    An investor can utilize these financial ratios to determine whether a manufacturing company is efficient, profitable and a good long-term investment option.
  5. Investing

    Fundamental Analysis for Traders

    Find out how the fundamental analysis method can be applied strategically to increase profits.
RELATED FAQS
  1. Profit margin versus operating margin: What's the difference?

    There are some distinctions between profit margin and operating margin. Both measure efficiency of a firm, but one takes ... Read Answer >>
  2. Gross Margin vs Operating Margin: What the difference?

    Understand the difference between gross margin and operating margin in relation to evaluating a company's overall profitability ... Read Answer >>
  3. How much can I borrow with a margin account?

    Understand the basics of margin accounts and buying on margin, including what amount investors can typically borrow for purchases ... Read Answer >>
  4. How can a company improve its net margin?

    Learn about what businesses can do to increase their net margin, including ways to increase sales revenue and decrease operational ... Read Answer >>
  5. What is a good operating margin for a business?

    Read about what it means to have a good operating margin and why that answer depends heavily on competitive and historical ... Read Answer >>
Trading Center