Within economics, margin is a concept used to describe the current level of consumption or production of a goods or service.Marginalism Definition. Investopedia. (2022). Retrieved 12 April 2022, from https://www.investopedia.com/terms/m/marginalism.asp. Margin also encompasses various concepts within economics, denoted as marginal concepts, which are used to explain the specific change in the quantity of goods and services produced and consumed. These concepts are central to the economic theory of marginalism. This is a theory that states that economic decisions are made in reference to incremental units at the margin, and it further suggests that the decision on whether an individual or entity will obtain additional units of a good or service depends on the marginal utility of the product.Stiglitz, J. (2000). The Contributions of the Economics of Information to Twentieth Century Economics. The Quarterly Journal Of Economics, 115(4), 1441–1478. https://doi.org/10.1162/003355300555015.
These marginal concepts are used to theorise various market behaviours and form the basis of price theory. It is a central idea within microeconomics and is used to predict the demand and supply of goods and services within an economy.Theory of Price Definition. Investopedia. (2020). Retrieved 22 May 2022, from https://www.investopedia.com/terms/t/theory-of-price.asp
Marginal concepts
Marginal cost Marginal cost is the change in monetary cost associated with an increase in the quantity of production of a certain good or service. It is measured in dollars per unit, and includes all the variable costs that alter depending on the level of production. Marginal cost differs from average cost as it solely provides the additional cost of one unit, rather than the average cost of each unit.Jakob, M. (2006). Marginal costs and co-benefits of energy efficiency investments. Energy Policy, 34(2), 172–187. https://doi.org/10.1016/j.enpol.2004.08.039
The marginal cost function is the slope of the total cost function. Thus, given a continuous and differentiable cost function, the marginal cost function is the derivative of the cost function with respect to the quantity produced.Nguyen, B., & Wait, A. (2016). Essentials of microeconomics (pp. 1–185). Routledge, Taylor & Francis Group.
Marginal utility
Marginal utility describes the added satisfaction or benefits a consumer will obtain by purchasing an additional product or service.Stigler, G. (1972). The Adoption of the Marginal Utility Theory. History Of Political Economy, 4(2), 571–586. https://doi.org/10.1215/00182702-4-2-571 The marginal utility can be positive, negative or zero. A negative marginal utility states that the user gains dissatisfaction from an additional unit, whilst a marginal utility of zero states that no satisfaction is gained from the additional unit.Gans, J., King, S., & Mankiw, G. (2011). Principles of microeconomics (pp. 65–94). Cengage Learning Australia.
Within marginal utility, the law of diminishing marginal utility describes that the benefit to a consumer of an additional unit is inversely related to the number of current units, demonstrating that the added benefit of each new unit is less than the unit prior.
An example of this could be demonstrated by a family buying dinner. The 1st plate of food would have a greater marginal utility than the 30th plate of food, as the families hunger would be reduced and they would thus obtain less value from it.
Marginal rate of substitution The marginal rate of substitution is the least favourable rate an individual or entity would exchange a good or service for another good or service.Marginal Rate of Substitution (MRS) Definition. Investopedia. (2022). Retrieved 7 April 2022, from https://www.investopedia.com/terms/m/marginal_rate_substitution.asp The marginal rate of substitution is associated with the value an individual or entity places on each unit, and would only trade if it provides a positive net value, whereby the value of the good or service obtained is greater than the one given away.
The marginal rate of substitution is calculated between two goods placed on the indifference curve, displaying the utility of each good. The slope of the utility curve represents the quantity of goods one would be satisfied in substituting for one another. There are however difficulties in quantifying the utility of different goods and services in comparison to one another, provide a critique of this framework.Benjamin, D., Heffetz, O., Kimball, M., & Rees-Jones, A. (2013). Can Marginal Rates of Substitution Be Inferred from Happiness Data? Evidence from Residency Choices. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.2221538
Marginal product In the theory of marginality, the marginal product of an input is the extra output obtained by adding one unit to a specific input.Blair, R., & Saygin, P. (2020). Uncertainty and the marginal revenue product–wage gap. Managerial And Decision Economics, 42(3), 564–569. https://doi.org/10.1002/mde.3254 This assumes all the other factors contributing to the output remain constant. For example, the marginal product of labour would be the added production when increasing a unit of labour, such as hours worked.
Marginality states that theoretically, the wage rate would equal the marginal product of labour. If the wage rate is below the marginal product of labour, profit-maximising businesses would continue to hire more employees until the marginal product reduces to the wage rate according to the law of diminishing return. Moreover, this theory can be applied to working capital, where businesses will employ more capital when the rate of interest on the capital is less than the marginal product. The value of the final product can thus be considered as a contribution of the various inputs and values derived by each.
Margin squeeze Margin squeeze is a pricing strategy implemented by vertically integrated companies who are the dominant provider of an input.Gaudin, G., & Mantzari, D. (2016).Margin squeeze: An above-cost predatory pricing approach. Journal Of Competition Law And Economics, 12(1), 151–179. https://doi.org/10.1093/joclec/nhv042 It is used to narrow the margin between the wholesale price of the input it controls and the downstream retail price to render other retailers unprofitable.Margin Squeeze. Mondaq.com. (2022). Retrieved 22 May 2022, from https://www.mondaq.com/advicecentre/content/1568/Margin-Squeeze. It hence squeezes the margin of a good or service. This squeezing of the margin can either be executed by increasing the price for the upstream product, decreasing the price of the downstream product or performing both simultaneously.
This strategy is viewed as an anti-competitive strategy and under anti-trust policies is prohibited in most competitive markets. The European courts considered that a margin squeeze constitutes specific and independent abuse, and the US supreme court deemed that it falls under the existing abuse of refusal to deal or predation. The European courts stated that the strategy "does not allow even an equally efficient competitor to trade profitably in the downstream market on a lasting basis", and is hence viewed as an illegal strategy.Julien, B., Rey, P., & Saavedra, C. (2014). The Economics of Margin Squeeze. Idei.fr. Retrieved 23 May 2022, from https://idei.fr/sites/default/files/medias/doc/by/jullien/Margin_Squeeze_Policy_Paper_revised_March_2014.pdf.
Applications within Price theory
Supply In both neoclassical economics and marginalism, supply curves are given by the marginal cost curve. The marginal cost curve is the marginal cost of an additional unit at each given quantity. The law of diminishing returns states the marginal cost of an additional unit of production for an organisation or business increases as the quantity produced increases. Consequently, the marginal cost curve is an increasing function for large quantities of supply.
Given a price set by a competitive market, a company will produce a product if the selling price is greater than the production cost of the unit.Perloff, J. (2021). Microeconomics (pp. 33–96). Pearson Education, Limited. The company will consequently produce products until the marginal cost of an additional unit is greater than the sale price.
Demand The demand curve within economics is founded within marginalism in terms of marginal utility. Marginal utility states that a buyer will attribute some level of benefit to an additional unit of consumption, and given the concept of diminishing marginal utility, the marginal utility of each new product will decrease as the overall quantity increases. Due to this, the demand curve will decrease as the quantity of goods increases.
Price theory states that the consumer will be willing to purchase an additional unit of a product if the marginal utility is greater than the cost of the good, as it provides a net benefit to the consumer. Given the marginal utility gradually decreases, the consumer will purchase additional units of a good or service until the marginal benefit of an additional unit is equal to the price of the unit as set by the market, shown by the intersection of the demand and cost functions.TURVEY, R. (2022). DEMAND AND SUPPLY (pp. 74–91). ROUTLEDGE.
An increase in price would consequently decrease demand for the individual as it would shift the cost curve up, and intersect the marginal utility curve at a point to the left of the original intersection, decreasing the quantity demanded. Since the demand of the market is the demand of all consumers combined, the market demand also follows this principle.
Market behaviour
Perfectly competitive environment
In defining circumstances where both suppliers and buyers are price takers, therefore allowing the demand and supply functions to not influence one another, marginalism and neoclassical economics can define models of perfect competition. However, it does not provide an accurate depiction in an imperfect environment. Within a perfectly competitive environment, marginalism is used within the principles of demand and supply to show that the intersection of the curves would be the market equilibrium.
This is the case as a company will only produce while the price is greater or equal to the marginal cost, given by the supply curve, and the consumer will only buy the good if the demand at that quantity is greater than the cost. The intersection point is consequently equilibrium as it is the price and quantity where a goods supply would equal its demand. Any natural deviation from this equilibrium would be naturally resolved within a competitive environment and return to this state.
Monopoly
In the instance of a company holding a monopoly over a particular market, the company now acts as price makers rather than price takers, and will regulate the quantity supplied and price sold to maximise profits. In an environment where they can not enact price discrimination, monopolistic companies will theoretically use the concept of marginalism to maximise profit.
Given a demand curve, a company's total revenue is equal to the product of the demand curve and quantity supplied. The marginal revenue curve can then be calculated as the derivative of the total revenue curve with respect to the quantity produced. This provides the additional revenue of each unit sold.
Given monopolistic companies act as price makers, and control the quantity supplied, they will produce at a quantity that allows them to maximise their profit.