Definition
Marginalism is an economic principle that refers to the additional benefit obtained from consuming, using, or producing one more unit of something. It is used to help make decisions about how to allocate resources efficiently, assess how much of a good to produce, or determine the price to charge for products or services. Essentially, if the marginal benefit of an extra unit exceeds its cost, it makes sense to continue production or consumption.
Key Takeaways
- Marginalism is a theory of economics that attempts to explain the discrepancy in the value of goods and services by reference to their secondary, or marginal, utility. It suggests that individuals make purchasing decisions based on the added (marginal) value an extra unit of a product or service offers.
- The theory of marginalism also introduces the concept of diminishing marginal utility, which indicates that the value derived from each additional unit decreases as consumption increases. This means that as more of a good or service is consumed, the less utility (satisfaction) the consumer derives from each additional unit.
- Marginalism plays a critical role in almost all economic decisions and it’s a foundational concept in microeconomics. It impacts pricing, production, consumption, and other economic decisions. Businesses, for instance, use marginalism to determine production levels, i.e., they aim to produce at a level where the marginal cost equals the marginal revenue.
Importance
Marginalism is a crucial concept in finance as it emphasizes optimal decision-making and resource allocation by considering the additional, or marginal, benefits and costs of an action.
It provides a practical approach to determining how much of a good or service should be produced or consumed to maximize utility or satisfaction.
Acting on the principle that rational individuals will only increase their consumption or production if the marginal benefit outweighs the marginal cost, marginalism supports understanding of how decisions related to supply and demand, pricing, and resource distribution are made in economic spheres.
This can lead to more effective business strategies, investment decisions, and financial planning, highlighting the significance of marginalism in the field of finance.
Explanation
Marginalism is a vital concept in economics that helps us understand how individuals and firms make decisions about allocation of resources. Its main purpose is to analyze the effects of incremental changes – the benefits or the costs associated with producing one more unit of a good or service, consuming one more unit, or allocating resources in a different manner.
Thus, it provides insight into how decisions are made under scarcity of resources and guides the direction of optimal decision-making, which ultimately aims at maximizing overall benefits or minimizing total costs. In the realm of economics, marginalism plays a pivotal role in making various decisions including consumption, production, pricing and investment.
For consumers, marginal thinking helps to determine the optimum level of consumption where additional satisfaction (marginal utility) from consumption is equated with the marginal cost. Companies also use marginal analysis to make production decisions.
For example, a manufacturer could use this approach to determine the number of items to produce, ensuring that the cost of producing an extra item (marginal cost) matches the revenue gained from selling that item (marginal revenue). Thus, marginalism proves to be a valuable tool in economic decision-making.
Examples of Marginalism
**Decision to Purchase an Additional Item:** One common example of marginalism in finance can be found in everyday consumer decisions. If you’re deciding whether or not to buy an additional item, you would weigh the benefit of the item against its cost. For example, let’s say you’re buying donuts. The first donut brings you a lot of satisfaction, therefore, you would buy it. But with each additional donut, the pleasure you derive from it may decrease. At the same time, the cost doesn’t change or it might even increase due to health concerns or diet restrictions. Eventually, there will be a point where the marginal cost of the additional donut would exceed the marginal benefit you receive from eating it, and no further donuts would be purchased.
**Business Production Decisions:** Businesses often use marginalism when deciding how much of a certain product to make. Suppose a shoe company is considering producing more shoes. They’ll analyze the marginal benefit (the potential revenue from selling another pair of shoes) and the marginal cost (the cost of the materials, labor, etc. to produce another pair). If the marginal benefit is greater than the marginal cost, they’ll produce and sell the extra pair of shoes. If not, they’ll stop production to prevent losses.
**Workforce Decisions:** Another example is deciding on how much labor to hire. If a company needs to require additional staffing, they will weigh the cost of hiring an additional employee against the expected returns or productivity gained by that employee. If the extra productivity (marginal benefit) outweighs the cost of hiring and paying a new employee (marginal cost), it makes sense to hire. When the marginal cost is greater than the marginal benefit, the hiring will stop.
Marginalism
What is Marginalism?
Marginalism is a theory of economics that attempts to explain the discrepancy in the value of goods and services by reference to their secondary, or marginal, utility. The reason why the price of diamonds is higher than that of water, for example, owes to the greater additional satisfaction of the diamonds over the water.
Who developed the concept of Marginalism?
The concept of marginalism was developed by economists Carl Menger, William Stanley Jevons, and Leon Walras in the late 19th century.
What is the principle of diminishing marginal utility?
The principle of diminishing marginal utility states that as a person increases consumption of a product – while keeping consumption of other products constant – there is a decline in the marginal utility that person derives from consuming each additional unit of that product.
What is the importance of Marginalism in economics?
Marginalism helps economists to understand how consumers and producers make decisions about allocation of resources. Marginalist theory guides us in making decisions like the quantity of goods to produce, the price to charge for it, and what kind of resources to use for its production.
What is marginal benefit?
A marginal benefit is the additional satisfaction or utility that a person receives from consuming an additional unit of a good or service. A person’s marginal benefit is the maximum amount they are willing to pay to consume that additional unit of a good or service.
Related Entrepreneurship Terms
- Opportunity Cost
- Cost-Benefit Analysis
- Marginal Cost
- Marginal Utility
- Law of Diminishing Returns
Sources for More Information
- Investopedia: A comprehensive website that specializes in finance and investment education, including key economic theories such as marginalism.
- Britannica: Encyclopedic reference site where a user can find well-researched articles on a wide range of topics, including economic theories like marginalism.
- Corporate Finance Institute (CFI): CFI provides online financial education programs and certifications. It covers a broad range of financial concepts, including marginalism.
- JSTOR: A digital library for scholars, researchers, and students. It provides access to thousands of academic papers, which could provide a more scholarly perspective on marginalism.
