Marginalism

MARGINALISM

• Marginalism is the decision-making of forward and not backward

process. Each decision has a corresponding benefit (marginal
benefit) and it has corresponding cost (marginal cost).
• The best way to understand the concept of Marginalism is by
understanding it in terms of Marginal benefit and Marginal cost.
Marginal benefit is the benefit a consumer or user gets after
consuming the next unit of same activity or commodity. Marginal
cost (MC) is the cost associated with the next unit of the same
activity. Economists can use Marginalism as a decision-making
paradigm in following two ways:
 MARGINALISM

• If the marginal benefit exceeds the marginal cost then the activity should be undertaken. i.e., if
MB > MC – Undertake the activity.
• If the marginal cost exceeds the marginal benefit then the activity should not be undertaken,
i.e., if MC > MB, -- Do not undertake the activity.
• Marginal analysis helps to assess the impact of a unit change in one variable on the other. For
example, a firms’ decision to change prices would depend on the resulting change in marginal
revenue and marginal cost. Changes in these variable would, in turn, depend on the units sold
as a result of a change in price. Change in the price is desirable if the additional revenue
earned is more than the additional cost. Similarly, decision on additional investment is taken on
the basis of the additional return from that investment, that is, the marginal changes.
 MARGINALISM

• When the resources are scarce, manage have to be careful about utilizing each and every
additional unit of resources or input. For example, if one has to decide whether an additional
man-hour or machine-hour is to be used, it is necessary to ascertain what is the additional
output expected from it. For all such additional magnitudes of output or return, economists use
the term “marginal”. It is a theory of economic, that attempts to explain the goods and
services by reference to their secondary or marginal utility.
• For example – why the price of diamonds is higher than that of water. When resources are
limited manager have to carefully decide about utilizing each and every additional unit of
resources
 Time Value of Money
(Through the concept of
Annuities)

The time value of money (TVM) is the idea that money available at
the present time is worth more than the same amount in the future
due to its potential earning capacity. This core principle of finance
holds that provided money can earn interest, any amount of money is
worth more the sooner it is received.
 Time Value of Money
(Through the concept of
Annuities)

Time value of money is the premise that an investor prefers

to receive a payment of a fixed amount of money today,
rather than an equal amount in the future, all else being
equal.
Time Value for Money
• TVM helps us in knowing the value of money invested. As time
changes value of money invested on any project/firm also
changes. And its present value is calculated by using
“mathematical formula”, which tell us the value of money with
respect to time. i.e.
• PV = . FV .
• (1 + i )n
• Where
• PV = Present Value
• FV = Future value (money to be received in the future)
• i = discount rate
• n = number of periods until fv is received.
 Reasons for Time Value of Money
• Risk and Uncertainty As we know future is never certain and we can’t
determine the risk involved in future because outflow of cash is in our
hand as payment whereas there is no certainty for future cash inflows.
• InflationIn an inflationary economy, the money received today, has more
purchasing power than the money to be received in future. In other
words, a rupee today represents a greater real purchasing power than a
rupee in future.
• Consumption Individuals generally prefer current consumption to future
consumption.
• Investment OpportunitiesAn investor can profitably use the received
money today to get higher return tomorrow or after a certain period of
time.
 Importance of Time Value of Money
• Investment Decisions Small businesses often have limited
resources to invest in business operations, activities and
expansion. One of the factors we have to look at is how to
invest, is the time value of money.
• Capital Budgeting DecisionsWhen a business chooses to invest
money in a project – such as expansion, a strategic acquisition
or just the purchase of a new piece of equipment – it may be
years before that project begins producing a positive cash flow.
The business needs to know whether those future cash flows
are worth the upfront investment.