Main Difference – Marginal Analysis vs Incremental Analysis
Making effective decisions in the competitive business environment is a challenging task managers have to deal with. Marginal analysis and incremental analysis are two approaches that help decision makers to make productive decisions. Marginal analysis focuses on incremental change of a particular variable to the change in another independent variable. In contrast, incremental analysis considers how to select the best alternative among several potential alternatives. This is the main difference between marginal analysis and incremental analysis.
This article explains,
1. What is Marginal Analysis?
2. What is Incremental Analysis
3. Difference Between Marginal Analysis and Incremental Analysis
What is Marginal Analysis
Marginal analysis, which comes under microeconomics theory, is an analysis that deals with marginal change in given economic variables. This is a useful decision-making tool that helps individuals and businesses to take decisions regarding allocation of their scarce resources while minimizing costs and maximizing benefits. Thus, marginal analysis measures the relationship between numerous economic variables and generates economic concepts such as marginal product, marginal cost, marginal revenue, marginal utility, etc.
In economics, this marginal theory is primarily used to calculate the optimizing behaviors of the economic variables. In a rational economy, individuals always try to maximize their satisfaction whilst business organizations try to maximize their profitability. Therefore, marginal analysis helps to identify the marginal increase or decrease of an independent variable and resultant increase or decrease of the dependent variable under consideration.
Example: If a particular firm decides to produce one more additional unit, the marginal cost of producing that product would be the additional amount that the company has to incur. On the other hand, marginal revenue that will generate by selling an additional unit is the amount of revenue derived from selling an additional unit under the same market conditions. Therefore, the company can decide whether to produce an additional product or not by looking at its marginal revenue and marginal cost.
What is Incremental Analysis
Incremental analysis is a relevant cost approach widely used in short term business / financial decision making. This technique uses cost behavior approach to make decisions and helps decision makers to choose the best among different alternatives. An incremental analysis focuses only on relevant costs or opportunity costs whereas sunk costs will be eliminated.
Example: A company wants to purchase a machine and have 2 options to invest in. The price of both machines is same. If the company buys option 1, it will generate $10,000 in one year period whereas if the company buys option 2, it will generate $15,000. Operating costs of both machines are same. In this scenario, the incremental revenue of selecting option 2 is $5,000. Other costs are considered as irrelevant as they are same for both options.
Similarities Between Marginal Analysis and Incremental Analysis
- Both approaches can be used in business financial decision-making
- Both approaches can be applied to different economic concepts such as cost, revenue, utility,
Difference Between Marginal Analysis and Incremental Analysis
Marginal Analysis is widely used in microeconomics.
Incremental Analysis is widely used by business decision makers, especially in investment decisions.
Marginal Analysis will be used in maximizing / minimizing decisions (Ex: identifying profit maximizing quantity, Break-even point etc.).
Incremental Analysis will be used to select the best option among different alternatives (Ex: limited resource decisions, Make or buy decisions, special order decisions etc.).
Marginal Analysis examines the costs and benefits of specific business decisions.
Incremental Analysis examines the most effective decision in term of maximizing potential benefits.
Marginal Analysis considers the relationship between economic variables against change in quantity.
Incremental Analysis consider accounting information to select the best alternative.
Types of Costs Considered
Marginal Analysis primarily consider variable costs / revenues.
Incremental Analysis takes into consideration opportunity costs and relevant costs. All the sunk costs are eliminated as they are already incurred and cannot be taken for future decision-making.
Marginal Analysis vs Incremental Analysis – Conclusion
Marginal analysis and incremental analysis are two techniques used in problem solving and decision making. Marginal analysis primarily focuses on assessing the impact of a unit change of a given variable pertaining to another variable. Decision makers use marginal analysis calculations to determine maximization / minimization points of volumes pertaining to cost, revenue, utility, etc. On the other hand, incremental analysis is a decision-making technique that is used to determine true cost effective alternative among a set of possible alternatives. This approach will help decision makers to decide on selecting the best option considering relevant, and opportunity costs involved with each alternative.
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