Marginal Analysis

Marginal is a fancy word for "one more," so marginal analysis is looking at the benefits of cost of one more unit, whether it be of production, labor, or anything else.

For example, the coffee shop sells doughnuts for $1, and maybe you're super happy at that cost for the first doughnut, but by your third you're starting to feel sick. Marginal analysis is not looking at your overall happiness from eating four doughnuts in total...it only looks at the benefits and cost (namely, hurling everywhere) from eating the fourth.

You know that moment. The one when you think “ehhh...just one more…” One more cookie...one more cup of coffee...one more bite. And then just one more. And one more. Until you realize that just one more...maybe isn’t such a good idea.

When you’re having a “just one more” moment, economists call this “thinking on the margin.”

“The margin” just refers to when you add one more. For instance, your marginal benefit of “just one more cookie” after you’ve already had one is probably still net positive. But after you’ve had 10 cookies, your stomach is a-rumblin’, saying “what are you doing to me? Why?” to which you say “I’m a slave to my tastebuds...what’s it to you, stomach?”

When the costs of “just one more” outweigh the benefits, it’s usually time to call it quits.

Our cookie example is an example of “the law of diminishing marginal returns,” which is just one way we can use marginal analysis. Diminishing marginal returns: when we get less and less benefit with the same input, so we get less and less enjoyment from each cookie with each additional cookie we eat, until eventually...it’s not enjoyable anymore. Like...your digestive system can only handle so much.

Marginal analysis is used just about everywhere...when we look at consumers consuming, when businesses are trying to minimize costs, and when governments are tinkering with models on how to incentivize us to do things.

Anytime you see the word “marginal,” like in marginal cost of production and marginal propensity to consume, it refers to “thinking on the margin.” When the input changes a tiny bit, how does that affect the output, and at what rate?

For instance, marginal propensity to consume asks, “When consumers have more disposable income in their pockets, how much more money are they spending?” As opposed to investing it, or hoarding it under their mattresses because they forgot inflation was a thing.

Marginal analysis is important for firms as well as cookie-eaters. Firms want to make just one more...just one more...just one more...of whatever they’re selling...say, waffle irons that make keyboard-shaped waffles...until they stop making money off of it. The keyboard-shaped waffle iron producers find that sweet spot where marginal costs equal marginal revenue, which is where the cost of just one more waffle iron equals the revenue they make by selling a waffle iron.

Just as, when you ate cookies, you basically ate them until your marginal cost equalled your marginal benefit. As long as the marginal benefit is higher than the marginal cost, it’s hard to say no to the cookies...whispering your name from the kitchen…

But when, all of a sudden, you realize that eating one more cookie is going to do more harm than good...when your marginal cost of just one more cookie is higher than your marginal benefit of just one more cookie...you call it quits. Unless you’re a masochist, then your marginal costs might also be benefits...but we’ll save that complication for Advanced Microeconomics.

The government uses marginal analysis on a mega-scale, in the “aggregate." Like when the Fed (as in: the Federal Reserve) lowers interest rates juuuuuusttttt a smidge of a percentage, making borrowing money cheaper, to try to get people to borrow just a smidge more.

Marginal analysis is all about tinkering. Add a little more, or take away a little...to see what happens. Like a mad scientist in a lab, who wants to give his interest rates...life.