Marginal Analysis Examples: Using a Marginal Analysis Formula

Marginal analysis is the process of examining the costs and benefits of a specific action to determine whether it generates profit. In microeconomics, the term marginal refers to buying one additional unit. Thus, marginal analysis determines whether the benefits of buying an additional unit or adding a new business activity offset the costs.

By identifying the causal relationship between two variables, marginal analysis functions as a key decision-making tool for businesses looking to expand operations; however, there are limitations of marginal analysis. Since it relies on a level of subjectivity in valuation, marginal analysis can result in a miscalculation of variable costs.

Marginal analysis helps companies allocate resources for profit maximization. Here are examples of marginal analysis in different contexts:

1. 1. Increasing production: When a company considers increasing its production rate, employees run a marginal analysis to identify whether additional production will benefit the business. Common costs the analysis considers include the cost of additional manufacturing equipment, the cost of hiring new employees, and the cost of increased raw materials. The marginal analysis formula determines whether the potential benefits, such as an increase in profits, outweigh the associated costs of new product lines.
2. 2. Financial decisions: Marginal analysis also applies to financial decisions surrounding opportunity cost. For example, companies across industries use marginal analysis to measure the additional benefit versus the additional cost of onboarding new employees. If the marginal analysis indicates additional employees will increase marginal revenue, then employers are more likely to hire.
3. 3. Operational efficiency: Companies also use marginal analysis to identify operational changes that improve efficiency. For instance, companies measure the impact of adding a new management software on operational efficiency. By measuring the cost of integrating the new software against the potential organizational cost reductions, businesses decide whether or not the new software has a positive effect on total output.

While marginal analysis considers both the costs and benefits of an activity, marginal cost refers only to the additional cost of adding a new product or activity. In mathematics, the change in total cost as quantity changes represents the marginal cost. As a result, a marginal analysis considers the marginal cost to determine the impact of a small change on profit potential.

As a cost-benefit analysis, marginal analysis considers how two variables change in relation to one another. The formula for marginal analysis is: net benefits = marginal benefits – marginal costs. Follow the below steps for calculating marginal analysis:

• Identify marginal benefits. The marginal benefits equal the additional value from new units of output. To find a marginal benefit, divide the change in total benefit by the change in quantity. As a formula, this reads as: marginal benefits = (new total benefit – old total benefit) / (new quantity / old quantity). The total benefit equals the sum of all marginal benefits.
• Identify marginal costs. After calculating marginal benefits, identify the marginal costs by dividing the change in total cost by the change in quantity. This formula appears as: marginal costs = (new total cost – old total cost) / (new quantity – old quantity). The total cost equals the sum of all marginal costs.
• Calculate marginal analysis. Use the marginal benefit and marginal cost you calculated to determine the marginal analysis. By subtracting the marginal costs from the marginal benefits, you can determine the net marginal benefit, which indicates whether or not the additional value of an extra unit or activity outweighs the additional costs.

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