Marginal Benefit Definition in Economics

Marginal benefit is the incremental value a customer perceives from purchasing and using an additional unit of a good or service. It is a pivotal economics concept in that companies must recognize that customers don't always value later units as much as initial units purchased. Any marginal benefit definition needs to take into account consumer activities, as well as market trends.

TL;DR (Too Long; Didn't Read)

The economic principle of diminishing marginal utility dictates that in most cases, the marginal benefit decreases with each additional unit of consumption.

Marginal Benefit Basics

A good marginal benefit definition and marginal benefit formula understands that the first unit of a good purchased has the highest value. If a customer pays $10 for a good, for instance, you could say the marginal benefit is $10. In reality, a customer may have a willingness to pay $12 or $15, which means the company may be missing an opportunity for more revenue in this marginal benefit example.

With many goods, a customer's perception of worth goes down on the second purchase and any subsequent purchases. If a customer buys a new winter coat for $100, the marginal benefit of buying another coat is likely not $100. The basic need has been met. In this marginal benefit example, the business offers two coats for $175, but the marginal benefit for the customer is $100 for one coat and $50 for a second, the deal probably won't work.

Business Applications

Marginal benefit has a number of important business applications, especially related to marketing and pricing strategies. Company operators need to realize that a customer compares the additional or marginal cost of a subsequent purchase to the marginal benefit, so a company's marginal benefit definition and formula must be forward thinking to be effective.

Here's a marginal benefit example for clarification: assume a cafe charges $2 for the first hot dog and $1.50 for the second. If a customer places a marginal benefit of $1.50 or more on the second hot dog, he may purchase it given the marginal cost of $1.50. However, if a customer typically gets full after one hot dog, the marginal cost of $1.50 for a second likely outweighs the marginal benefit. Companies often conduct research to identify the optimum price point for such deals and to arrive at an effective marginal benefit formula.

An additional consideration for a business is the added expense of selling a second item relative to selling a first. Many companies factor in the cost of acquiring a customer when pricing initial purchases. Those costs aren't relevant, then, on a subsequent purchase. Therefore, the company has more room to adjust prices to align with marginal benefits, and can create a marginal benefit formula for second, third and fourth purchases.

Things to Consider

There are a few things to consider when taking marginal benefit into account for your business plans and projections. For instance:

  • Timing: Pay attention to consumer buying trends so you know when to offer bulk deals or emails with discounts at restock time. If you price a little higher with the first sale, you have wiggle room on pricing for repeat sales. When your pricing meets perfect timing and with your customer's perception of  marginal benefit, you will make sales. 

  • Overhead Cost: When your overhead and production costs are too high, it becomes challenging to make your prices low enough to match the marginal benefit. Consider ways to lower your overhead, manufacture goods more reasonably and/or increase the perceived value of your goods. 

  • Trends: Trends come and go, so invest in market research to get ahead of the game in offering the latest trends first and raise the marginal benefit of your goods. Market research will also let you know when to drop an old trend and find a new one to enhance your product. 

References

About the Author

Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007. He has been a college marketing professor since 2004. Kokemuller has additional professional experience in marketing, retail and small business. He holds a Master of Business Administration from Iowa State University.