How Is Marginal Analysis Used in Economics?
The word "marginal" means additional or incremental. This word is used constantly in economics. As any Econ 101 professor will tell you, every decision we make is an economic decision. It doesn't matter if it involves money, time, land or the environment, whatever people decide to do with our scarce resources results from economic decision-making; and all decisions are made at the margin.
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Thinking at the Margin
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Most of our thinking and decision making is done at the margin. In other words, we do not make our decisions based on what to do with the rest of our lives, we decide based on the next, incremental amount of time -- whether it is the next semester, the next day, the next hour or the next 10 minutes. Whether you watch TV tonight or study for your exam, stop at a coffee shop before work or go straight there, these decisions all happen at the margin.
Marginal Benefits
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Whether we realize it or not, we evaluate each decision based on what type of benefit it is going to bring us. Some of these benefits might be financial, such as the additional money you receive in your paycheck when you volunteer for an extra shift at work. Some decisions might bring other types of satisfaction, such as the pleasure you get from going to the movies with friends.
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Marginal Costs
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As economists love to say, "There is no such thing as a free lunch." This means that everything has a cost. Every decision we make involves costs, and not all of them are monetary in nature. And since our decisions are made at the margin, we refer to them as marginal costs.
Economics uses the concept of opportunity cost, which is the cost of the next best alternative. When you make a decision, such as the decision to take an extra class next semester, there are costs involved. Certainly, the extra class increases your tuition bill. But you are also giving up all the things you could be doing -- work, leisure, studying for other classes -- with that extra time. These opportunity costs must be taken into consideration when you make a decision. As economic decision makers, we evaluate whether our decision creates a marginal benefit that compensates for these marginal costs.
Marginal Product
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Another important concept in economics that involves marginal analysis is marginal product. Marginal product means the amount of additional production a firm gets from additional units of input. An easy way to look at marginal product is to think of labor as the input. Every firm needs labor to produce its good or service. But the firm needs to know how much additional production it gets when it hires an additional worker. The firm will hire the additional worker if the marginal revenue exceeds the marginal cost of hiring that worker.
At some point, the addition of new workers begins to create a situation of declining additional productivity. This is called diminishing marginal product.
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