Explain what is meant by marginal analysis. What costs are considered by managers when following marginal analysis? Compare and contrast the use of marginal analysis and break-even analysis for evaluating business decisions.
Week 2 Discussion Question
Explain what is meant by marginal analysis.
Marginal analysis refers to the analysis of benefits and costs associated with the marginal units or additional unit of a good or even an input. Whenever the management of McDonald’s fast food chain wanted to increase the products, they analyze the cost and the benefits they stand to get by producing more hamburgers. They analyze the cost and benefits of producing each extra unit of hamburgers. For example, according to McDonalds Kuwait, producing 12 more hamburgers will mean working one more hours or overtime. This means that for an extra hour at work, the company can produce and sell 12 more hamburgers. The management mainly analyze the total change in a system when any of the component variables is manipulated (Horngren, 1978).
What costs are considered by managers when following marginal analysis?
When doing conducting marginal analysis, the managers mainly focus on how the changes in any of the choice variables may affect the objective function. Any change that increase the objective function helps in the realization of the maximization objectives. Therefore, sunk costs, fixed costs and average costs are ignored. On the other hand, the variable costs are the one they give consideration to. Manager must know the variable costs because these are relevant in the production process. They are not sunk costs and neither are they fixed costs to be ignored.
Compare and contrast the use of marginal analysis and break-even analysis for evaluating business decisions.
Break even analysis refers to the technique for analyzing the minimum price, minimum level of activity or the break even point at which the company will not be making any profit or loss. Break even analysis therefore can only be used by the managers to set the level of activity, the selling prices as well the margin of safety. Moreover, marginal costs are used for long term planning, while break even analysis is used for short term planning (Sullivan, &, Schifrin, 2003, n the other hand, Atrill, & McLaney, (2012) argues that the break even analysis is founded on the assumption that the value of sales and the variable costs do not change. Additionally, the break even analysis assumes that the variable costs can only vary with the unit change in the level of activity. The marginal cost on the other hand, believes that variable cost is not constant but only changes with the changes with the level of activity.
Secondly, while the marginal analysis mainly focuses on maximizing utility or profit or revenue, the break even focuses on the point at which the company does not make profit or loss (stability). finally, marginal analysis focuses on specific products or specific division or market segment while the great even analysis provide the bigger pictures as it focuses on the entire organization. Marginal analysis is not commonly used because it’s usually hard to differentiae the fixed costs from the variable costs. Secondly, the this method is suitable for specific organization such as manufacturing industries and specifically focuses on the sales aspect of business operations unlike standard costing as well as the budgetary control. Last but not least, break even analysis is prepared from the information provided by the marginal costing
Marginal analysis is many done to determine how much an entity can maximize its utility. For example, while the consumers are more interested in the benefits they will realize from consuming one extra hamburger, McDonalds is focusing on how much profits it can make by producing one extra hamburger, or by using one more labor hours. In this regards, marginal analysis may specifically mean the marginal revenue, the marginal products of a company, or its marginal rate of substitution. Additionally, marginal analysis may mean magical cost analysis or marginal propensity to consume or save. The main underlying concept is the extra unit that can optimize utility
Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 111
Atrill, P., & McLaney, E. (2012). Management accounting for decision makers. Harlow, England, Pearson Education Limited
HORNGREN, C. T. (1978). Introduction to management accounting = (formerly Accounting for management control, an introduction). Englewood Cliffs, N.J., Prentice-Hall.