Often in economics we refer to decisions taken at the margin. This can be confusing for those not familiar with the term. Marginal analysis basically looks at the last consumption or production unit. It is very different to looking at total cost or total Revenue
The easiest way to explain is using example. Let us look at Marginal Cost.
Definition Marginal Cost
– Marginal cost MC is the cost of producing the last unit of a good.
|Q||Total Cost (TC)||Marginal Cost (MC)|
- The Marginal cost of producing the third unit is 7. This is because the total cost has increased from 16 to 23
- The marginal cost of producing the fifth unit is 13, because total cost has increased from 32 to 45.
Note, the Average cost of producing 5 units is 9 (45/9)
- The Marginal cost is always the increase in total cost from last unit
Diagram of Marginal Cost
Definition of Marginal Utility The utility gained from consuming the last unit of a good.
For example, if you consume one cake, your marginal utility may be quite high – say 10 units of satisfaction
- If you consume a second cake (in same day) your marginal utility of the second cake is likely to fall quite a bit to say +2
- If you consume three cakes, you may even start to feel ill and get negative utility from a third cake.
- Note: You may really like cake, but your marginal utility may soon fall for extra units.
- see: Marginal Utility Theory
Importance of Marginal Analysis
Why do you spend £1,000 on a diamond and £0.10 on a glass of tap water?
Well one reason is that your marginal utility of your first diamond is high. But, your marginal utility for diamonds would soon fall.
With water, you will consume much more over your lifetime, because you need it everyday.
No Use Crying Over Spilled Milk
If you buy Christmas Trees for £5, does it make sense to sell them for £1?
Well, it can do. Once you have bought Christmas trees, you have spent all your money. The marginal cost of selling trees is then very low.
If you have unsold trees on Christmas eve, it is better to sell for £1, than to have unsold stock which costs money to destroy in the New Year.
For an airline, the marginal cost of selling an extra seat on a plane is very low. Most costs of flying are fixed. Therefore, once the plane is scheduled to fly, the marginal cost of an extra passenger is very low, so it makes sense to fill the plane up as much as possible.