Managers must be equipped with essential strategies for making optimal decisions on various levels of business. In our day-to-day life, we are quite often faced with the task of making decisions over issues. We are also forced to give up a certain thing so as to gain the option that is taken. The marginal analysis enables us to make better choices by weighing the marginal benefit against the marginal cost. The decision an administrator has to make should be of the ultimate benefit to society. One would be able to study the external economic environment by analyzing the foundation of the market structure. (Hirschey, 2009).
This paper explains some concepts of economic marginal analysis to several economic choices that are commonly made today. Sometimes making the ultimate decision seems very easy, for instance, if one wishes to buy something new, then they choice depend on the taste, preference and the budget. Other times the choice is very difficult especially when the needs seem equally important and one must make a sacrifice of an option over another. When a choice is to be made the main determining factors are the marginal cost and the marginal benefits.
The marginal costs are those extra costs imposed due to additional production while marginal benefits are the additional advantages due to more production. A good efficient and economical decision is made at the efficient level of output when the marginal benefit is equivalent to the marginal cost. Although the cost-benefit analysis is considered to be very useful in deciding over difficult situations, some situations will not work out in accordance with the marginal analysis. These are cases that have to do with molarities and fairness.
In line with Maurice and Thomas (2008), on Marginal Analysis, the management of Ford Company had to make the ultimate decision of delaying the marketing and selling introducing their new models “The 2002 Explorer” in the market so as to have it checked for quality and performance. Most people would have argued that the marginal cost of the delay in the aim of quality control would be too high for the benefits. This was an optimal decision by the executives considering that previously they had suffered a hefty three billion loss over massive recall of the original Explorer. The marginal benefits of having a new model that would not face a recall out weighted the marginal cost of the quality control exercise and thus the delay of the vehicles into the market. The Ford Company CEO had to weigh between cost and benefits and make a decision over a new model ‘Redesigned Explorer’. In line with Maurice and Thomas on Marginal Analysis for Optimal Decision, (2008), “A manager decision is optimal if it leads to the best outcome under a given set of circumstances”
The optimization theory calls for one to make a wise judgment over options. As outline by Maurice and Thomas (2009), the essential principle of optimal decision making is only a formal way of utilizing commonsense in making a choice. Managerial economics entails making key decisions that concern the firm’s goals and profits such as the number of employees, expenditures and costs. It involves a procedure known as the analytical as a foundation for maximizing profits. The analysis focuses on production, consumer behaviors and input choices. The manager has to consider the effect a decision will have with regards to benefits and the costs incurred. Changing the business activities either causes the cost to raise more than benefits or vise versa. A good manager monitors the outcome of a decision they have made and makes required adjustments until the maximum point where no more net gain can be achieved. At that point, the optimal value or level has been reached and that is the fundamental logic of making optimal conclusions.
For a producer, the optimizing behavior involves trying to adjust the chances of making maximum profits while the consumer will try to maximize satisfaction. For a manager, it will be an adjustment of the laws to minimize the expenditure and maximize income. The adjustments are made to the objective function. If the objective function is cost then the problem involves minimization while a benefit involves maximization.
In the cases of maximization or minimization problems, especially when the value is almost at the optimal point, the analysis and adjustment required are marginal since they involve very slight but significant changes. The objective function that should marginally be analyzed ought to be the net benefit which is as a result of the total cost incurred and the total benefits achieved just as net pay is gross pay minus the deduction. According to Maurice and Thomas, (2008), “the marginal cost or benefit is the change in total benefit or cost per unit charge in the level of an activity”.
Presumably, a situation calls for apparent decisions about an entire project. Arguably, sometimes the marginal benefits and cost analysis seem ambiguous since the objective function to be analyzed may not be continuous. These are complex scenarios that call for one to avoid using the efficiency standard discriminatively since this can easily lead to dangerous conclusions. According to McConnell and Bruce on ‘Economics: principles, problems, and policies’, “Purposeful (rational) behavior does not assume that people and institutions are immune from faulty logic and therefore are perfect decision-makers, sometimes they make mistakes.” Humanity may compromise efficiency standards by causing the decision-maker to incline to morality and fairness.
According to Welker (2009), the issue of the opportunity cost does not count on some activities. People react from their personal rational being for instance, why should a person who earns 100 dollars an hour consider mowing the lawn for two hours? Economically the opportunity cost would be 200 dollars while someone else can be hired to do it at 20 dollars thus relieving the owner for leisure or other quantifying or valuable jobs. One activity may seem to appear as a manual job to someone while to another its leisure and therefore they will not consider the marginal costs and benefits over it. According to Tacker (2008), one of the main economic decisions people make is considering the opportunity cost but “Economics assumes that human behavior reflects ‘rational self-interest.’ Individuals look for and pursue opportunities to increase their utility.”
Necessity is the mother of all inventions. The US dependence on Middle East oil led to the invention of electric cars and this created a wrangle between the government and the environmentalist over which mechanism was more suitable for the future of America. Considering this scenario a customer has to make an optimal analysis to choose between the hybrids gasoline-electric cars or gasoline cars. The sale of the hybrid vehicle was initially very low considering their high-cost price and maintenance as compared to the oil prices. Most people easily made their choice for gasoline due to the obvious economical viability. After the Iraq-Lebanon war, the oil prices went up and people started to consider hybrids.
The marginal analysis can be applied to the decision customers have to make. The process would involve an analytical process of computing the marginal benefits and cost of switching from gasoline to the hybrid. The compromise, in this case, would be the marginal benefit compared to the marginal cost of switching. The main benefit would be reduced fuel usage in comparison to the cost of accruing the hybrid technology.
Hypothetically considering a client who wishes to have a hybrid car for one year, the marginal analysis of switching according to Maurice and Thomas (2008), would amount to a marginal benefit that is greater than the marginal cost. This would greatly vary depending on the fluctuations in the prices of fuel. This scenario shows why most clients are now switching to environmentally friendly hybrid cars. Economists will consider a more complete measure as a marginal benefit that has an extra advantage, especially to the society. In this case, other than the owner, other people would benefit from the hybrid purchases due to its minimal pollution of the environment. This caters to the social well-being of people and the probability of switching back to gasoline vehicles in the future would be too low even if the fuel prices fell.
“The method of marginal analysis involves comparing marginal benefits and marginal costs to see if the net benefits can be increased by making an incremental change in activity level” (Maurice and Thomas, 2008).
References
Hirschey, M. (2009). Managerial Economic (12th Ed). Madison, OH: Cengage Learning
Maurice, S., & Thomas, C. (2008) Managerial economics (9th Ed.) New York, NY: McGraw-Hill.
McConnel, C. R., and Brue, S.L. (2005). Economics: principles, problems, and Policies (7th Ed). New York, NY: McGraw-Hill publishers.
Tucker, I.B., (2008). Survey of Economics Madison, OH: Cengage Learning.
Welker, J. (2009). Behavioral Economics: Introduction to Economic Way of Thinking. Web.