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economics Economics () is the social science that studies the production, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics anal ...
, margin is a concept used to describe the current level of consumption or production of a good or service.Marginalism Definition. Investopedia. (2022). Retrieved 12 April 2022, from https://www.investopedia.com/terms/m/marginalism.asp#:~:text=Marginalism%20is%20the%20economic%20principle,buying%2C%20selling%2C%20etc.). 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 Marginalism is a theory of economics that attempts to explain the discrepancy in the value of goods and services by reference to their secondary, or marginal, utility. It states that the reason why the price of diamonds is higher than that of wa ...
. This is a theory that states that economic decisions are made in reference to incremental units at the margin,Reading: Marginal Utility , Microeconomics. Courses.lumenlearning.com. (2022). Retrieved 12 April 2022, from https://courses.lumenlearning.com/suny-microeconomics/chapter/marginal-utility/. and it further suggests that the decision on whether an individual or entity will obtain additional units of a good or service depending on the
marginal utility In economics, utility is the satisfaction or benefit derived by consuming a product. The marginal utility of a good or service describes how much pleasure or satisfaction is gained by consumers as a result of the increase or decrease in consump ...
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 Microeconomics is a branch of mainstream economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics fo ...
and is used to predict the demand and supply of goods and services within an economy.


Marginal concepts


Marginal cost

Marginal cost In economics, the marginal cost is the change in the total cost that arises when the quantity produced is incremented, the cost of producing additional quantity. In some contexts, it refers to an increment of one unit of output, and in others it ...
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. 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. 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 Dinner usually refers to what is in many Western cultures the largest and most formal meal of the day, which is eaten in the evening. Historically, the largest meal used to be eaten around midday, and called dinner. Especially among the elite ...
. 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 Substitution may refer to: Arts and media *Chord substitution, in music, swapping one chord for a related one within a chord progression *Substitution (poetry), a variation in poetic scansion * "Substitution" (song), a 2009 song by Silversun Pic ...
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#:~:text=In%20economics%2C%20the%20marginal%20rate,theory%20to%20analyze%20consumer%20behavior. The marginal rate of substitution is associated with the
value Value or values may refer to: Ethics and social * Value (ethics) wherein said concept may be construed as treating actions themselves as abstract objects, associating value to them ** Values (Western philosophy) expands the notion of value beyo ...
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 In economics, an indifference curve connects points on a graph representing different quantities of two goods, points between which a consumer is ''indifferent''. That is, any combinations of two products indicated by the curve will provide the c ...
, displaying the utility of each good. The
slope In mathematics, the slope or gradient of a line is a number that describes both the ''direction'' and the ''steepness'' of the line. Slope is often denoted by the letter ''m''; there is no clear answer to the question why the letter ''m'' is use ...
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.


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 A wage is payment made by an employer to an employee for work done in a specific period of time. Some examples of wage payments include compensatory payments such as ''minimum wage'', '' prevailing wage'', and ''yearly bonuses,'' and remune ...
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 Employment is a relationship between two parties regulating the provision of paid labour services. Usually based on a contract, one party, the employer, which might be a corporation, a not-for-profit organization, a co-operative, or any ot ...
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 Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...
, 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. It is used to narrow the margin between the
wholesale Wholesaling or distributing is the sale of goods or merchandise to retailers; to industrial, commercial, institutional or other professional business users; or to other wholesalers (wholesale businesses) and related subordinated services. I ...
price of the input it controls and the downstream retail price to render other retailers unprofitable. It hence squeezes the margin of a good or service. This squeezing of the margin can either be executed by increasing the
price A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the ...
for the upstream product, decreasing the price of the downstream product or performing both simultaneously. This
strategy Strategy (from Greek στρατηγία ''stratēgia'', "art of troop leader; office of general, command, generalship") is a general plan to achieve one or more long-term or overall goals under conditions of uncertainty. In the sense of the " ...
is viewed as an anti-competitive strategy and under anti-trust policies is prohibited in most competitive markets. The European
courts A court is any person or institution, often as a government institution, with the authority to adjudicate legal disputes between parties and carry out the administration of justice in civil, criminal, and administrative matters in accorda ...
considered that a margin squeeze constitutes specific and independent
abuse Abuse is the improper usage or treatment of a thing, often to unfairly or improperly gain benefit. Abuse can come in many forms, such as: physical or verbal maltreatment, injury, assault, violation, rape, unjust practices, crimes, or other t ...
, and the
US supreme court The Supreme Court of the United States (SCOTUS) is the highest court in the federal judiciary of the United States. It has ultimate appellate jurisdiction over all U.S. federal court cases, and over state court cases that involve a point of ...
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 http://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 Neoclassical economics is an approach to economics in which the production, consumption and valuation (pricing) of goods and services are observed as driven by the supply and demand model. According to this line of thought, the value of a good ...
and
marginalism Marginalism is a theory of economics that attempts to explain the discrepancy in the value of goods and services by reference to their secondary, or marginal, utility. It states that the reason why the price of diamonds is higher than that of wa ...
, 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 Business is the practice of making one's living or making money by producing or buying and selling products (such as goods and services). It is also "any activity or enterprise entered into for profit." Having a business name does not separ ...
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 In economics, competition is a scenario where different economic firmsThis article follows the general economic convention of referring to all actors as firms; examples in include individuals and brands or divisions within the same (legal) firm ...
, a
company A company, abbreviated as co., is a legal entity representing an association of people, whether natural, legal or a mixture of both, with a specific objective. Company members share a common purpose and unite to achieve specific, declared ...
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 In economics, a demand curve is a graph depicting the relationship between the price of a certain commodity (the ''y''-axis) and the quantity of that commodity that is demanded at that price (the ''x''-axis). Demand curves can be used either for ...
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 In economics, utility is the satisfaction or benefit derived by consuming a product. The marginal utility of a good or service describes how much pleasure or satisfaction is gained by consumers as a result of the increase or decrease in consump ...
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 In economics, a cost curve is a graph of the costs of production as a function of total quantity produced. In a free market economy, productively efficient firms optimize their production process by minimizing cost consistent with each possible ...
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 In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In theoretical models whe ...
. 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 whilst 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 A monopoly (from Greek language, Greek el, μόνος, mónos, single, alone, label=none and el, πωλεῖν, pōleîn, to sell, label=none), as described by Irving Fisher, is a market with the "absence of competition", creating a situati ...
over a particular market, the company now acts as
price A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the ...
makers rather than price takers, and will regulate the quantity supplied and price sold to maximise
profit Profit may refer to: Business and law * Profit (accounting), the difference between the purchase price and the costs of bringing to market * Profit (economics), normal profit and economic profit * Profit (real property), a nonpossessory inter ...
s. In an environment where they can not enact price discrimination, monopolistic companies will theoretically utilise 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 In mathematics, the derivative of a function of a real variable measures the sensitivity to change of the function value (output value) with respect to a change in its argument (input value). Derivatives are a fundamental tool of calculus. ...
of the total revenue curve with respect to the quantity produced. This provides the additional
revenue In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business. Commercial revenue may also be referred to as sales or as turnover. Some companies receive rev ...
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. Therefore they will produce until the marginal cost curve is greater than the marginal revenue curve, as any products sold after will incur a decrease from the maximum profit, and the price will be set by the demand function at that given quantity.Greenlaw, S., & Shapiro, D. (2022). How a Profit-Maximizing Monopoly Chooses Output and Price. Opentextbc.ca. Retrieved 8 May 2022, from https://opentextbc.ca/principlesofeconomics2eopenstax/chapter/how-a-profit-maximizing-monopoly-chooses-output-and-price/#:~:text=A%20monopolist%20can%20determine%20its,should%20produce%20the%20extra%20unit.


Criticisms

There are several critiques of the theory of marginal utility. A major
critique Critique is a method of disciplined, systematic study of a written or oral discourse. Although critique is commonly understood as fault finding and negative judgment,Rodolphe Gasché (2007''The honor of thinking: critique, theory, philosophy''p ...
is that the theory ignores how an individual's valuation of a good or service may be dependent on their reference point and personal circumstances and they may not act as ‘rationale’.Critiques of Expected Utility Theory. Princeton.edu. (2009). Retrieved 8 May 2022, from https://www.princeton.edu/~dixitak/Teaching/EconomicsOfUncertainty/Slides&Notes/Notes10.pdf. Psychologists have suggested that people's perceptions and judgements are influenced by their reference position. This is demonstrated by Richard Thaler’s
endowment Endowment most often refers to: *A term for human penis size It may also refer to: Finance * Financial endowment, pertaining to funds or property donated to institutions or individuals (e.g., college endowment) *Endowment mortgage, a mortgage to ...
effect experiment, whereby individuals were sold small objects and then offered an option for the item to be bought back from them. He found that people would only sell the product at a premium, demonstrating that the value of the good was higher when viewed as something that could be lost compared to something that could be acquired. John List however performed a similar experiment with trading cards and found these subjects were less influenced by endowment. His research suggested that traders learnt from prior experiences and make decisions based on long term value, rather than the emotions associated with the loss of the good. Moreover, findings suggest that benefits and costs are processed in different parts of the
brain A brain is an organ (biology), organ that serves as the center of the nervous system in all vertebrate and most invertebrate animals. It is located in the head, usually close to the sensory organs for senses such as Visual perception, vision. I ...
and thus may not be perfectly correlated. The uncertainty over how much
marginal utility In economics, utility is the satisfaction or benefit derived by consuming a product. The marginal utility of a good or service describes how much pleasure or satisfaction is gained by consumers as a result of the increase or decrease in consump ...
an individual will give to a certain good or service and its dependence on their individual reference point and context makes it difficult to quantify each individual's marginal utility for a certain product. However, marginal utility theory assumes this deviation to be non-existent and the consumer to be perfectly
rational Rationality is the quality of being guided by or based on reasons. In this regard, a person acts rationally if they have a good reason for what they do or a belief is rational if it is based on strong evidence. This quality can apply to an abi ...
and uniform. Therefore, there is no certainty that people will act as theorised and they are expected to deviate, limiting this theory. Another key limitation of margin is how marginal change is measured. Quantifying the
marginal utility In economics, utility is the satisfaction or benefit derived by consuming a product. The marginal utility of a good or service describes how much pleasure or satisfaction is gained by consumers as a result of the increase or decrease in consump ...
of certain products and services such as
food Food is any substance consumed by an organism for nutritional support. Food is usually of plant, animal, or fungal origin, and contains essential nutrients, such as carbohydrates, fats, proteins, vitamins, or minerals. The substance is in ...
may be difficult as utility is a subjective value and thus individuals may struggle to associate a numerical value to it. The theory also assumes the marginal utility of
money Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money ar ...
to be constant, however, this is not true in practice as the value of each additional dollar decreases as the overall quantity of money increases. Thus the marginal utility of money can be considered non-uniform in practice. For example, gaining $1 after having only $2 is worth more than gaining $1 after having $2,000,000.


Alternate theories


Labour theory of value The labor theory of value (LTV) is a theory of value that argues that the economic value of a good or service is determined by the total amount of " socially necessary labor" required to produce it. The LTV is usually associated with Marxian ...

The labour theory of value is an economic theory that states that the value of a good or service is quantified by the ‘socially necessary labour’ required to produce it. The theory is often associated with
Marxian economics Marxian economics, or the Marxian school of economics, is a heterodox school of political economic thought. Its foundations can be traced back to Karl Marx's critique of political economy. However, unlike critics of political economy, Marxian ...
and is central to his theory that centres on how
capitalism Capitalism is an economic system based on the private ownership of the means of production and their operation for profit. Central characteristics of capitalism include capital accumulation, competitive markets, price system, private ...
exploits the
working class The working class (or labouring class) comprises those engaged in manual-labour occupations or industrial work, who are remunerated via waged or salaried contracts. Working-class occupations (see also " Designation of workers by collar colou ...
. This theory values a good or service based on the duration and intensity of labour required to produce it. The theory also encompasses the
means of production The means of production is a term which describes land, labor and capital that can be used to produce products (such as goods or services); however, the term can also refer to anything that is used to produce products. It can also be used as a ...
, referring to the
tools A tool is an object that can extend an individual's ability to modify features of the surrounding environment or help them accomplish a particular task. Although many animals use simple tools, only human beings, whose use of stone tools dates ba ...
, materials, power and other means required to produce the goods or services that are a result of prior labour. In its simplest form, the final value of a product is equal to the sum of the value of labour time( average skill and productivity) and the value of the means of production, also known as constant capital.


Diamond-water paradox

The labour theory of value was used to explain the Diamond-Water paradox as proposed by
Adam Smith Adam Smith (baptized 1723 – 17 July 1790) was a Scottish economist and philosopher who was a pioneer in the thinking of political economy and key figure during the Scottish Enlightenment. Seen by some as "The Father of Economics"——� ...
. It asserts that although
diamonds Diamond is a solid form of the element carbon with its atoms arranged in a crystal structure called diamond cubic. Another solid form of carbon known as graphite is the chemically stable form of carbon at room temperature and pressure, ...
had minimal practical value compared to
water Water (chemical formula ) is an inorganic, transparent, tasteless, odorless, and nearly colorless chemical substance, which is the main constituent of Earth's hydrosphere and the fluids of all known living organisms (in which it acts as ...
back in the
19th century The 19th (nineteenth) century began on 1 January 1801 ( MDCCCI), and ended on 31 December 1900 ( MCM). The 19th century was the ninth century of the 2nd millennium. The 19th century was characterized by vast social upheaval. Slavery was abolish ...
, the value demanded by diamonds exceeds the value of water, a resource which was essential to life and had many applications. Smith used this to support the labour theory of value, suggesting that value associated with diamonds was reflective of the labour required to obtain them, compared to water, a more readily available resource. He argued that this supports how the cost of a good is determined by its labour cost compared to use value.Smith, A. (1998). An Inquiry Into the Nature and Causes of the Wealth of Nations. Electric Book Co. Marginalism advocates however argued that Smith misunderstood marginalism fundamentally. They claimed that the marginal usefulness can only be attributed as a specific quantity, rather than categorically. For most individuals,
water Water (chemical formula ) is an inorganic, transparent, tasteless, odorless, and nearly colorless chemical substance, which is the main constituent of Earth's hydrosphere and the fluids of all known living organisms (in which it acts as ...
is sufficiently abundant, therefore the value of an additional loss or gain of a gallon of water would be very minor, whereas the rarity of diamonds means the gain or loss of one diamond would be more significant. The first
gallon The gallon is a unit of volume in imperial units and United States customary units. Three different versions are in current use: *the imperial gallon (imp gal), defined as , which is or was used in the United Kingdom, Ireland, Canada, Aust ...
of water an individual has access to would have more value than the first diamond, however, each subsequent gallon would have reduced value, to the point where the first diamond would have more value than the nth gallon. The notion is a result of diminishing marginal utility.


See also

*
Marginalism Marginalism is a theory of economics that attempts to explain the discrepancy in the value of goods and services by reference to their secondary, or marginal, utility. It states that the reason why the price of diamonds is higher than that of wa ...
*
Marginal utility In economics, utility is the satisfaction or benefit derived by consuming a product. The marginal utility of a good or service describes how much pleasure or satisfaction is gained by consumers as a result of the increase or decrease in consump ...
*
Labor theory of value The labor theory of value (LTV) is a theory of value that argues that the economic value of a good or service is determined by the total amount of " socially necessary labor" required to produce it. The LTV is usually associated with Marxian ...
*
Monopoly A monopoly (from Greek language, Greek el, μόνος, mónos, single, alone, label=none and el, πωλεῖν, pōleîn, to sell, label=none), as described by Irving Fisher, is a market with the "absence of competition", creating a situati ...


References

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Margin Margin may refer to: Physical or graphical edges * Margin (typography), the white space that surrounds the content of a page *Continental margin, the zone of the ocean floor that separates the thin oceanic crust from thick continental crust *Leaf ...