Marginalism

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21 Aug, 2024

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Marginalism is an economic theory that emphasizes the significance of marginal changes in economic decision-making. The theory aims to explain the fact that the individuals make decisions based on the marginal benefit or cost of a specific action, rather than the total benefit or cost.

Marginalism is a crucial component of microeconomic theory, as it explains how market prices and quantities are determined. This theory also emphasizes the importance of marginal changes in decision-making and how they can lead to market equilibrium. The theory describes how market prices and quantities are determined by interacting with consumers' marginal utility and producers' marginal costs.

Marginalism Meaning

Marginalism is an economic school of thought that focuses on the significance of small changes in economic decision-making.
It assumes that people make decisions based on a certain action's marginal cost or benefit rather than the overall cost or benefit.
While incrementalism is commonly used in management and public policy fields like budgeting and planning, marginalism is more prevalent in the study of microeconomics.
The use of marginalism is to aid decision-making by analyzing small incremental changes in costs and benefits.

Marginalism Principle Explained

Marginalism theory was first proposed in the late 19th century by economists William Stanley Jevons, Carl Menger, and Léon Walras. They independently developed similar ideas about how individuals and firms make decisions in a market economy. Moreover, marginalism is an essential part of microeconomic theory, widely used to analyze and comprehend economic behavior and market outcomes.

The basic idea behind marginalism is that individuals and businesses make decisions based on the marginal changes in benefits and costs associated with an action. For example, consumers will continue to buy more units of a good or service if the marginal utility exceeds the marginal cost. For producers, this means they will continue to produce additional units of a good or service as long as the marginal cost is less than the marginal revenue.

The intersection of the marginal utility and marginal cost schedules for consumers and the marginal cost and marginal revenue schedules for producers determines the market equilibrium, where the quantity of the good or service supplied is equal to the quantity demanded.

Marginalism is also important in welfare economics, as it helps to design public policies that can improve economic welfare by understanding how individuals and firms make decisions based on marginal changes in benefits and costs.

Uses

Marginalism has several important uses in economics, including:

First, marginalism helps explain how individuals decide what goods and services to purchase based on the marginal benefit and marginal cost of each additional unit consumed.
Marginal analysis is used to set prices in many industries. By comparing the marginal cost of producing an additional unit to the marginal benefit (revenue) that the unit will generate, firms can determine the optimal price to charge.
Marginalism can help in the efficient allocation of resources in an economy. By comparing the marginal benefit of a particular use of a resource to its marginal cost, policymakers can determine the best use of the resource.
Marginal analysis is used to evaluate the impact of policies on the economy. Policymakers can assess a policy's marginal cost and marginal benefit to determine whether it will be effective and efficient.
Businesses use marginalism to make decisions about production, investment, and hiring. Businesses can determine the optimal production, investment, and staffing level by comparing these decisions' marginal cost and marginal benefit.

Examples

Let us look at marginalism examples to understand the concept better:

Examples #1

When a consumer is contemplating buying an additional product unit, such as a chocolate bar, they will consider the marginal benefit or added utility of consuming one more unit. For example, if the consumer enjoys eating chocolate, they may estimate that the marginal utility of the 9th chocolate bar is 8 "utils."

In addition to the marginal benefit, the consumer will consider the marginal cost of purchasing one more unit. For example, if the chocolate bar costs $2, the consumer will evaluate whether the marginal utility of consuming one more unit (8 utils) is greater than the marginal cost of purchasing it ($2).

Based on this analysis, the consumer will decide whether to buy the additional chocolate bar. This decision is based on the principle of marginalism, which emphasizes the importance of considering a decision's marginal benefit and marginal cost rather than the total benefit or cost.

Examples #2

A farmer has 100 acres of land under cultivation and considers the added benefit or marginal revenue from planting one more acre of crops. For example, an additional acre of crops may generate $1,100 in marginal revenue, considering the revenue from selling crops grown on that acre minus the costs of planting and harvesting.

The farmer also considers the additional or marginal cost of planting an additional acre, which could include the cost of seeds, fertilizer, labor, and equipment. If the marginal revenue exceeds the marginal cost, estimated at $900, the farmer will decide whether to plant an additional acre of crops.

This decision-making process based on marginal changes in benefits and costs is central to the marginalism theory. As inputs fluctuate, the farmer will re-evaluate the marginal cost and revenue to determine whether to plant more or less to optimize production and yield the highest profit.

Marginalism vs Incrementalism

The difference between marginalism and incrementalism is as follows:

Basis	Marginalism	Incrementalism
Definition	An economic theory focuses on decisions individuals or firms make regarding production, consumption, and pricing based on a particular action's marginal benefit and marginal cost.	A decision-making and problem-solving approach that emphasizes small, gradual changes over large, drastic changes, based on the premise that small changes can lead to larger, long-term gains.
Focus on	Marginal benefit and marginal cost.	Small and gradual changes.
Purpose	To optimize decision-making and resource allocation.	To achieve long-term gains through small changes.
Application	Production, consumption, and pricing decisions.	Budgeting, planning, and problem-solving.
Strengths	Provides a clear framework for decision-making and emphasizes efficiency.	Allows for flexibility and adaptability and emphasizes long-term gains.
Weaknesses	Assumes rational decision-making and does not account for systemic issues.	It may not be suitable for addressing immediate crises or urgent issues and may not lead to significant change quickly.

Frequently Asked Questions (FAQs)

What is equi-marginalism?

Equi-marginalism is an economic principle that suggests an individual will allocate their resources so that the marginal utility per unit of currency spent is equal across all goods and services. This principle assumes that individuals will strive to maximize their total utility subject to budget constraints.

What is geometric marginalism?

Geometric marginalism is an economic theory that uses geometric shapes to represent marginal utility and marginal cost. It assumes that the value of goods and services decreases as more of them are consumed, and the optimal point of consumption occurs when the marginal cost and marginal utility intersect on the graph.

What are the disadvantages of the marginalism concept?

One disadvantage of marginalism is that it assumes that people have perfect information and can accurately calculate their decisions' marginal costs and benefits, which is not always the case. Another disadvantage is that it may narrowly focus on individual decision-making rather than considering broader social and environmental impacts.