Marginalism and Incrementalism
- In economic theory any firm makes a decision to produce by equating marginal revenues with marginal costs. (MR=MC).
- Marginal Revenue – is the change in Total revenue resulting from an one–unit change
in the volume of output produce (firm decides to produce n+1).
- Marginal Cost-It refers to the cost of produ-cing additional unit of output.
- Marginal Product – it is the addition made to total produce as a result of employing an additional factor of production. (Labour)
- In making economic decision, management is interested in knowing the impact of a chunk-change rather than a unit change .
- Marginal concepts are always defined in terms of unit changes, but incremental concepts are defined in terms of chunk changes .
- Incremental principle concept refers to :
- Incremental Revenue – Change in total revenue caused by a decision.
IR = TR (IR = Incremental Revenue)
Q (TR = Total Revenue)
(Q= Total Output)
IR = TR
I (I = Total Investment)
- Incremental Cost – Change in total cost.
- IC = TC (IC = Incremental Cost)
- Q (TC = Total Cost)
(Q = Total Output)
- Managerial Rule of Thumb-
q IR >IC
- An automobile firm adopts a new factory plant to increase its output. This may involve a rise in its total cost by 20% against increase in output by 10%.
- IC = 20% = 2%
q On other hand, firm expects rise in total sale revenue by 30% because of increase in 10% output.
qIR = 30% = 3% ( IR= 3% > IC = 2%)
- The incremental principle may be stated as under :
A decision is obviously a profitable one if
(i) It increases revenue more than costs.
(ii) Reduces costs more than revenue
Incremental revenue and incremental cost are
two basic concepts for making optimum
economic decisions. A decision is optimum if it
reduces cost more than revenue i.e. if the net
incremental revenue is positive.
- Since resources are limited a very fundamental questions arises : How to decide on an optim-um allocation of resources. When we use resources, we get returns in either physical volume or its money value.
- If there is only one resource, then we may go on utilizing it till its Marginal return is zero i.e. Do not go beyond zero marginal return , if a resource has only one use. This is known as ” absolute activity level principle”.