The marginal benefit of any good or service is the additional satisfaction, or utility, a consumer receives from the consumption of one additional unit of a good or service. Marginal benefit is maximized at the highest price the consumer is willing to pay for that additional unit. In most cases, marginal benefit declines as further consumption increases, under the Law of Diminishing Returns.
An Example of Marginal Benefit
As a manufacturer, marginal benefit is the amount over/under your market price at which you can sell one additional unit. Marginal benefit is expressed in the exchange unit used to acquire one additional unit of a good or service. Typically, this is currency, which in the U.S. is the dollar. Suppose that after eating one hot dog, you want to have another. How much benefit will you get from eating one more hot dog? And, how much are you willing to pay for it, regardless of its actual price?
If you are willing to pay $5 for that additional hot dog, then its marginal benefit is worth $5 to you. Because the measurement of benefit in this case is personal, the next person may have a different marginal benefit. If the actual price of the hot dog is $2, the difference between it and the price you are willing to pay is a consumer surplus, which in this case is $3.
The same principle applies on the producer side. If you sell hot dogs for $2 regularly, but a shortage of hot dogs increases demand to the point that you can raise the price to $3, you are realizing a $1 marginal benefit. Of course, this could be offset by any increase in your marginal costs. Raising your price too much can lower profits by driving customers away, but pricing your product too low can cut into your profits because as operating costs rise, a larger share of your profit will go to running the business.
To set appropriate prices, research the market for your product. Find out what other businesses are charging and what consumers are willing to pay. An important part of market research is testing price points, which you can do through A/B testing and direct surveys with your target audience. You'll also need to determine your costs for sourcing, shipping and storing the product to determine your profit margin with your price point.
Applying Marginal Benefit Concept to the Seller
So, how does the concept of marginal benefits get applied to the mindset of the seller?
Let's say you have a food truck that sells hot dogs at $5 each. The cost of the meat, buns and condiments is $2.75 per unit. This leaves a gross profit of $2.25 per unit. We'll ignore the fixed costs of operations for this analysis.
On a normal day, you sell 100 units. This produces a gross profit of $2.25 x 100 units, or $225.
But you would like to increase sales, so, you decide to lower the price to $4.50 each. At this price, you would make a gross profit of $1.75 per unit.
As expected, sales increase to 175 units. The first 100 consumers were happy to pay $5, so they're even happier to pay $4.50. Even better, 75 more consumers are now willing to pay $4.50. The gross profit is now 175 units times $1.75 or $306.25.
Following the same logic, lowering the price to $4 leads to total sales of 250 units and a gross profit of $312.50 ($1.25 unit gross profit times 250 units). Total gross profits increased $6.25 ($312.50 minus $306.25) for additional sales of 75 units.
As the seller, is it worth your time and effort to cook and sell an additional 75 hot dogs to receive a marginal increase in profits of $6.25? That depends on your own perception of the required marginal benefit to your business of the additional sales.
James Woodruff has been a management consultant to more than 1,000 small businesses. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company's operational, financial and business management issues. James has been writing business and finance related topics for National Funding, PocketSense, Bizfluent.com, FastCapital360, Kapitus, Smallbusiness.chron.com and e-commerce websites since 2007. He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University.