What Is Marginalism?

Marginalism is the economic principle that economic decisions are made and economic behavior occurs in terms of incremental units, rather than categorically. The key insight of marginalism is that people make decisions over specific units of economic goods (economists say "at the margin"), rather than in an all-or-none fashion.

Understanding Marginalism

Marginalism has formed one of the foundational principles of economic theory and research since its adoption in the 1870s, known as the Marginal Revolution. At its cor♏e, the idea of marginalism is simple: each additional unit has its own level of utility. For consumers, each additional unit consumed has a specific amount of benefit. For manufacturers, each ad👍ditional unit produced will have specific costs.

Concepts that originate from the principle of marginalism include marginal utility; marginal costs and benefits; marginal rates of substitution and transformation; and marginal propensities to consume, save, or invest. These are all core ideas of modern micro- and macroeconomics, and marginal thinking, in general, is widely regarded by economists a🐟s an important component of what𒁏 it means to be an economist.

How Marginalism Developed

The idea of marginalism was separately developed by three European 澳洲幸运5官方开奖结果体彩网:economists, Carl Menger, William Stanely Jevons, and Leon Walras, in the 19th century. It resolves the Diamond-Water Paradox that was described by Adam Smith. The Diamond-Water Paradox asserts that because diamonds (which at the time had little practical use) command a far higher market price than water, which has many uses and is necessary for human survival, then use value must not be the deciding factor in the values and market prices of economic goods. Smith used this argument to support his 澳洲幸运5官方开奖结果体彩网:labor theory of value and oppose previous ideas that use value was more important.

The marginalists argued that Smith had gotten it wrong in a fundamental way. The values that people place on economic goods and the prices they set for them don't consider broad categories of goods, such as all water or all diamonds, in terms of either their use value or their labor cost. Rather, the values are based on the specific uses that people have for each individual unit of a good. People will naturally put the first unit of a good they are able to obtain to their most highly valued use, and use subsequent marginal units for less and less valued ends. This is known as the concept of 澳洲幸运5官方开奖结果体彩网:diminishing marginal utility.

This explains why diamonds (usually) command a higher market price than water: People value diamonds and water for their marginal use value, and diamonds are rare relative to their usefulness, while water literally fa🎀lls out of the sky and springs up out of the earth for free.

Thus, an average human being is willing to pay more for an additional diamond than for an additional glass of water. In places where usable water is scarce, such as deserts or a ship adrift at sea, the rever♍se may be true, and people will gladly trade all the diamonds they may have in return for a single cup꧅ of water to drink in order to survive.

This concept of 澳洲幸运5官方开奖结果体彩网:marginal utility was then used to derive the 澳洲幸运5官方开奖结果体彩网:laws of supply and demand as we know them, and its application to all areas of economics swept the profession, replacing the labor theory of value and other older ideas. Because economics is essentially the scie💖nce of how people use and value economic goo𒉰ds in order to achieve their limitless wants and needs with limited and scarce resources at hand, marginal thinking is ubiquitous in all areas of economics.

Example of Marginalism

Marginalism is not just a theoretical idea; it can be seen across all sorts of𒀰 real-world human action. Indeed, this is why🍌 the insight of marginalism is so powerful and why it became so important to economists.

For example, if you sit down for breakfast to eat a plate of eggs ൩and bacon, you are making a decision at the margin. On an average day, you might eat two eggs and three strips of bacon to meet your basic nutritional needs, or you might eat a third egg if you have some strenuous physical activity or work planned for the day.

In either case, you decide how many eggs to eat based on the use value you place on each egg. In no case do you decide between whether to eat all the eggs that exist in the universe or else zero eggs. You are making a marginal decision rather than a categorical decision, so marginal analysis can be applied to understanding how you decide and help you find ༒a solution that will best fit your needs.

Take this example one step further: Consider the marginal benefit of eating a fourth egg, fifth egg, or sixth egg. At any given point, you may actually sta☂rt to not feel well and begin to have negative marginal utility; that is, each additional egg you eat may make you sick. It is up to the consumer to decide how much incremental benefit each additional item consumed has and base their decision-making on that.

Law of Diminishing Marginal Returns

The law of diminishing marginal returns, also known as the law of diminishing marginal product, is a fundamental concept in economics and production theory. It states that as additional units of a variable input are added to a fixed quantity of another input, the marginal (additional) output or product produced from each additional unit of the variable input will eventually decrease, assuming all other factors remain constant.

In simpler terms, the law suggests that there comes a point where adding more of a variable input yields smaller and smaller increases in output. The l🌞aw has important implications for p🔜roduction and resource allocation because it helps businesses and policymakers make decisions about the optimal level of input use.

As an example, imagine a farm with a fixed amount of land. Initially, adding more labor (the variable input) can lead to a significant increase in crop production. However, after a certain point, adding more labor might overcrowd the field, causing workers to get in each other's way. In this latter case, the additional output from each new unit of labor starts to decrease.

Marginal Rate of Substitution

The 澳洲幸运5官方开奖结果体彩网:marꦫginal rate of substitution (MRS) is another important concept in economics related to marginalism. It represents the rate at which a con🌠sumer is willing to exchange one good for another while remaining equally satisfied. In other words, it's a way to measure when a consumer keeps their utility constant.

MRS is calculated as the negative ratio of the marginal utility of one good to the marginal utility of another. If MRS is constant, the consumer is willing to trade a fixed amount of one good for another while maintaining the same level of satisfaction. If the MRS is h🍸igh (in absolute value), it indicates a strong preference for the good in the numerator. If tౠhe MRS is low (in absolute value), it indicates a weak preference for the good in the numerator.

Let's look at another example. You're on a budget and have dedicated $20 to grab some food at your favorite drive-thru restaurant. You know you want at least two hamburgers for $5 each. With the remaining $10, you can opt for a few extra hamburgers, some french fries, a drink, or an ice cream. However, you have to gauge the marginal utility of each as you can't afford it all. Marginalism, in this context, is weighing the value of each incremental item against each other (as the utility of the first hamburger is different than the utility of the third hamburger).

Applications of Marginalism

The practice of marginalism has a wide range of applications across various fields and sectors. These uses may include but aren't necessarily limited to the applications below.

Consumer Choices

澳洲幸运5官方开奖结果体彩网:Marginal analysis is fundamental in understanding how consumers make decisions about what to buy. It helps explain why consumers buy more of one good or service and less of another based on the 澳洲幸运5官方开奖结果体彩网:additional utility or satisfaction they derive from each additional unit of the good. It also helps determine how many of a given level a co�ꦺ�nsumer may buy.

Production Levels

Businesses use marginal analysis to determine the level of production that maximizes profit. By comparing the 澳洲幸运5官方开奖结果体彩网:marginal cost (the cost of producing one more unit) with the marginal revenue (the revenue from selling one more unit), firms can make informed decisions about ho🎶w much to produce. All else being equal, it is often most economically viable for a firm to continuing manufacturing goods as lo💙ng as the marginal revenue exceeds the marginal cost of each additional unit made.

Resource Allocation

Marginal analysis plays a crucial role in allocating resources efficiently. In both business and gove𒊎rnment, it helps assess different𝐆 projects or investments by weighing their marginal benefits and marginal costs. It can also help in life as well. For example, consider a busy college student weighing homework, time spent on clubs, and the party they were invited to tonight. The student inherently applies marginalism when considering the value of each minute spent at each.

Pricing Strategies

Businesses set prices based on marginal analysis. They consider the marginal cost of producing one more unit of a good or service and the marginal utility of consumers to 澳洲幸运5官方开奖结果体彩网:maximize profits while satisfying customer demandไ. All else being equal, a busi♔ness may be able to increase the price if the marginal revenue received outpaces the marginal cost and loss of demand for the good.

Investment Decisions

Investors use marginal analysis to ev🉐aluate the expected return on investments. By comparing the marginal costs such as the cost of buying additional shares of a stock with the m💜arginal benefits (the expected increase in value), investors inherently decide whether an investment is worth it using marginalism whether they realize it or not.

Supply Chain Management

Companies use marginal analysis to optimize inventory levels and logistics. By evaluating the marginal costs of holding inventory and the 澳洲幸运5官方开奖结果体彩网:marginal benefits of timely delivery, they can improve supply chain efficiency. This can be done by analyzing𒀰 how each incremental good o𒈔r raw material will pass through the supply chain,

Criticisms of Marginalism

Marginalism, though a foundational concept in economics, has several criticisms. For starters, marginalism often assumes that individuals are perfectly rational in their decision-making. In many cases, this may not accurately reflect real-world behavior. Human decisions are influenced by emotions, cognitive biases, and limited information; you know that the one extra slice of pizza may leave you with a stomach ache, but that may not𓆏 aඣlways stop you.

Critics also may argue that marginalism tends to focus on micro-level decision-making and may not adequately address macroeconomic issues, such as economic growth, unemployment, or inflation. It often dis⛦regards factors such as social norms, ethics, and psychologica🤡l well-being that are broader concepts.

There are also a handful of smaller, economic assumptions. Marginal analysis assumes that changes in inputs or outputs are continuous and smooth, which isn't always the case. Marginal analysis may be difficult to measure, especially when unit-to-unit changes are small. Marginalism may also assume that all individuals are the same, which may not reflect the diversity of real-world preferences and behaviors.

The Bottom Line

The ideas behind marginalism allowed economists to explain the complexities of human economic decisions and understand human behavior. By analyzing how the utility of a good can change "at the margins," with the addition or subtraction of just one unit, a whole new way of looking at economics became possible.