Understanding Marginal in Economics: Diminishing Marginal Returns, Revenue, and Cost
When we hear the term 'marginal' in economics, we often encounter phrases like diminishing marginal returns, marginal revenue, and marginal cost. These concepts are fundamental to understanding business decisions and economic theory. Let's delve into what ‘on the margin’ means and why economists frequently use this term.
What Does "On the Margin" Mean?
The phrase "on the margin" in economics refers to the point where the change in outcome from a slight increase or decrease is insignificant. Essentially, it suggests that an additional unit of input or output does not significantly affect the overall outcome. In simpler terms, a marginal change is small and does not substantially alter the situation.
For example, if a business decides to open a new store, it looks at the marginal cost of doing so. If the additional cost equals the additional revenue generated (marginal revenue), the business sees no net benefit. However, if the marginal revenue exceeds the marginal cost, the business can expect a net profit, but if marginal cost exceeds marginal revenue, the additional store becomes a financial burden.
The Concept of Marginal in Economics
In economics, the term 'marginal' is often used to describe the cost or revenue of the very next unit of a product or service. It is a key idea because it helps analyze the impact of small, incremental changes. By focusing on the marginal outcomes, economists and businesses can better manage resources and make more informed decisions.
Consider a firm expanding its store franchise. The firm will continue opening new outlets as long as the marginal revenue (additional revenue from selling one more unit) exceeds the marginal cost (additional cost of producing one more unit). However, once marginal revenue equals marginal cost, it reaches the profit-maximizing point for its current portfolio. If the firm were to open just one more store, it would enter a realm of diminishing marginal returns.
Diminishing Marginal Returns
Diminishing marginal returns, or the law of diminishing returns, states that as one factor of production is increased while holding all other factors constant, there will be a point at which the additional output (marginal product) will start to decrease. This is a critical concept in production planning and capacity management.
For instance, if a company hires more workers, the output continues to rise, but the additional output from each new worker begins to decline beyond a certain point. This phase is crucial for managers to plan and optimize their production capacities effectively.
Marginal Analysis in Austrian Economics
Austrian economics, often associated with the Austrian School of Economics, places great emphasis on marginal analysis. Austrian economists view the 'marginal' unit as the smallest, indivisible unit of production or consumption. They avoid using the term 'average' because it can be misleading. The concept of averages can be complex and may not accurately reflect the current situation.
For example, if a company increases production, the average cost per unit might initially decrease but then start to increase. This complexity is why Austrian economists focus on the marginal cost and marginal revenue of each additional unit. They believe that focusing on the marginal unit provides more precise decision-making data.
Key Concepts in Economics
Marginal Cost (MC) Marginal Revenue (MR) Marginal Product (MP) Marginal Return (MRP)Marginal cost (MC) is the cost of producing one additional unit. Marginal revenue (MR) is the additional revenue from selling one more unit. Marginal product (MP) is the additional output produced by one more unit of a variable input. Marginal return (MRP) is the profit generated from the marginal product, which is the marginal revenue less the marginal cost.
To summarize, the term 'marginal' in economics refers to the impact of a small, incremental change. This concept is crucial for understanding economic relationships and making informed business decisions. By focusing on the marginal outcomes, businesses can optimize their operations and ensure maximum profitability. The law of diminishing returns and marginal analysis help managers understand production limits and make well-informed choices.