Sometimes, businesses might want or have to produce more. In this case, they need to pay attention to a number of factors. These factors include marginal benefits and marginal cost, which are changes in general benefits and costs whenever there’s a change in production. Understanding how they work and the differences between them is essential, as this can have a great positive impact on your business.
Why are marginal benefits and marginal cost important?
These two concepts are important for customers as they are for businesses. Economists say that, when they want to buy something, customers make decisions at the margin. This means they tend to evaluate the resources they need to acquire a product, and would incline for the one with the lower cost. Also, they are often forced to choose between items if they remain with less funds after a previous buying session. However, satisfaction, or benefits, are extremely important as well.
Therefore, a businessperson needs to understand what marginal benefits and marginal cost mean. Judging from this marginal perspective, they will know what strategy to adopt and how to make production more profitable.
What are marginal benefits?
The marginal benefit is that extra utility or satisfaction that comes from buying one more unit of a product or a service. For a person, the marginal benefit is the maximum amount of money they are eager to pay to get that extra unit. Usually, if consumption increases, this marginal benefit should decrease.
Marginal benefits for customers
Therefore, the idea of marginal benefit is related to that satisfaction that comes from the utility of the product, or from the act of consuming more. The physical way to express marginal benefits is through that amount of money spend on one extra unit. Therefore, customers should find some inner value in the product that equals the money they spent on it.
For instance, let’s say a person wants some pieces of jewelry and goes to a shop to purchase some. The person picks a pair of earrings that costs $100. For this, the person should find a value in these earrings that is worth at least $100.
Now, marginal benefits manifest themselves as such. The person already has a pair of earrings, and they might not be willing to spend another $100 on another pair. However, the seller can convince the person to take one more item for a price of $50. In this case, the marginal benefit is the difference between the two sums, namely $50.
Marginal benefits for producers
The same thing applies for producers and businesspeople as well. They acquire marginal benefits with each extra item they sell. If an object has a certain selling price, the marginal benefit of the producer will be this exact same price acquired for each item sold. In different situation, the marginal benefits might change.
If the industry stops working so well, you might have to change the price of the products to sell them. As a result, the marginal benefits will decrease. In the other case, the industry can go really well, and there might be a high demand for your products on the market. If this happens, you can even afford to increase your marginal benefits.
What is marginal cost?
Marginal benefits and marginal cost are strictly related. Therefore, understanding one of them is almost impossible without understanding the other. Marginal cost is related mostly to businesspeople and to the act of production.
Just like its name suggests, the marginal cost is the extra cost a producer has to spend to manufacture one more item. At first, these costs will be higher, as the business isn’t established yet and the resources are not unlimited. Then, as the business grows and you start producing more, you can afford reducing the marginal cost.
However, there is an unpleasant situation that can occur. There is one moment when you reach your full resources and capacity. You are already using all the equipment and putting the workers to a lot of work, and there’s only one way to increase production even more. The solution is buying new equipment and hiring new people. As a result, your marginal cost will increase.
Usually, this happens in a bad moment for the market. When it is overly saturated, the marginal benefits and marginal costs are the opposite of one another. The first ones get smaller, while the other ones get higher, and it gets harder for you to acquire some profit.
Marginal benefits and marginal cost
The idea of a successful business is to have marginal benefits bigger than marginal costs. In other words, the revenue brought by selling one item should be bigger than the costs needed to produce that item. This is what profit means.
In this case, the ideal solution is to continue the production. The profit will remain stable, and you will afford satisfying the demand on the market. However, you should keep increasing production up to a certain point. When the marginal benefits equal the marginal cost, it’s time to reduce production. This moment is described as the profit-maximizing level of output.
If you continue producing even after this level, your marginal cost will exceed the marginal profits. Therefore, the costs will be higher than the revenue, and you won’t get any profit. The link between marginal benefits and marginal cost teaches us that a smaller production is still profitable.
The profitability of a business depends on the consumer surplus as well. This notion represents the difference between the amount of money customers are willing to pay and the actual price of the item. In a positive scenario, customers are willing to pay more than the actual price, meaning that the marginal benefits are bigger for them.
As long as there is this consumer surplus, customers will continue adding value to products and items and will continue purchasing them.
Marginal benefits and marginal cost are two notions that are essential in business. One depends on the other, and a small value of one of them is usually associated with a high value of the other. Before starting production, it’s important to understand how to control them. The strategy to avoid losses isn’t that complicated, and it only requires a bit of attention to the two concepts.
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