Business owners must understand the relationship between the cost of your products and services and the returns on your investment. One way to gauge this aspect of the business is to understand the marginal benefit, a concept in economics. A thorough understanding of marginal benefit sets your business for financial success.
The shorter version of marginal benefit’s definition is it’s the maximum amount a consumer will pay for a product and service. It can also refer to the additional satisfaction that a consumer receives when they buy your products and services. Businesses perform marginal benefit analysis to determine the best possible price point for any deal.
In this article, we’ll define marginal benefit, break down its concept, evaluate its importance and explain how it works.
What’s Marginal Benefit?
When a client is willing to pay the highest amount for an additional unit of a product or service, that amount is the marginal benefit “marginal utility.” It’s the change in benefit due to the change in the number of units that a customer already has. The term “utility” describes how satisfied a customer is with their products or services.
For example, if a customer buys a burger meal for $10, then they are obtaining at least $10 o the item’s perceived value.
Marginal benefit can also be referred to as marginal revenue. In business terms, the more additional units a customer sells of a service or product, the less revenue they’re bringing in. This is because the action keeps lowering the price of each product or service to sell as an additional unit.
In product advertising and business market research, marginal benefits come with a variety of uses. A business must think about how each client looks at the marginal cost of buying another unit versus the marginal benefit derived from the product and services.
Aside from using the data to determine potential costs necessary to sell more units, companies can also use the information to set up the pricing strategy for specific products and services.
There are three types of marginal benefits:
- Zero marginal benefit. This takes place when a consumer uses more of a unit that doesn’t bring more satisfaction or negative consequences. For example, a customer may stop eating after four slices of pizza and eating another slice is not an option. In this case, the marginal benefit from consuming the pizza is zero.
- Positive marginal benefit. This occurs when consuming more units of a product or service makes a consumer happier. Going back to the pizza example, a customer who loves eating pizza would be happy to get a second slice. Hence, the marginal benefit of eating another slice is positive.
- Negative marginal benefit. This happens when the customer consumes too much of a product and service, and the additional consumption incites a negative reaction. For example, eating a seventh slice of pizza can make a person sick.
How Does Marginal Benefit Work?
Here’s a scenario: for example, a shop sells a pair of shoes for $50. However, the customer is willing to pay $60 for the pair. In this instance, the marginal benefit is $60 since that’s the most willing a customer is to pay for the product. This means the marginal benefit is $10 higher than the original selling price.
Another important aspect of marginal benefit is how the change in quantity affects it. In most cases, the marginal benefit decreases as customers consume more products and vice versa. This is because a consumer starts to lose interest in owning a product if they already have it. In contrast, the less you have of a product, the more compelled you are to buy it.
Going back to the shoe example, the customer might be willing to pay $60 for the first pair, $50 for the second and $40 for the third. The more they purchase the shoes, the marginal benefit continues to decrease. If the customer wants to keep the price of the shoes constant at $50, only two pairs of shoes would be sold due to the marginal benefit of the third pair (which is less than the asking price).
Understanding Falling Marginal Benefit
As the buyer consumes more units of a product or service, they will receive less satisfaction or utility from the consumption. Using the shoe example, when a consumer spends $50 for a $60 pair of shoes, the marginal benefit is $50. The more shoes a customer buys, the less they want to spend on their next pair.
This concept explains how consumers make purchasing decisions according to their budgets. In general, customers will continue buying certain units with marginal benefits that are higher than the cost. In a perfect market, the unit price equates to the marginal cost.
Why is Marginal Benefit Important?
Marginal benefit is a great tool that can measure the change in quantity versus the change in benefits. If you are a business owner, you’ll want the marginal benefit to always outweigh the cost. This ensures your clients are always interested in your services ad goods. It also keeps you from lowering the cost of the products too much.
If you decide to lower the cost for the second or third pair of shoes, this could entice customers to buy more pairs of shoes because they are on sale. As long as your price reduction outweighs the cost of making more shoes, it’ll be good for your business. Plus, the shoes’ price reduction is a benefit to you since this results in fewer payments for the additional good services or products.
How Do You Find the Marginal Benefit?
The formula for calculating the marginal benefit is change in total benefit or change in the number of units consumed.
You can get the change in total benefits by deducting the overall benefit from the buyer’s current consumption from their previous consumption.
For example, a customer consumes their first slice of cake and gains a benefit of 10 units. Their second slice of cake leads to a total benefit of 18 units. To get the change in total benefit, deduct the total benefit of the first slice of cake from the second one. If you subtract 10 from 18, you’ll get a total benefit of 8.
As for the change in the number of units consumed, this is derived by deducting the amount of the unit that the buyer is currently consuming from their previously consumed units. The change in units consumed from the second and first slice of cake is 1 (2-1).
How Can Businesses Use Marginal Benefit?
As mentioned above, businesses can use the marginal benefit to determine how much they can decrease the price of an additional product to entice a customer to buy again. Business leaders must decide on what price point would convince returning customers to buy the same product again. However, the price must be high enough so they can still make a profit.
Marginal benefit can also be used as a marketing technique. In deciding a product or service’s marginal product, businesses must consider the needs and values of customers. Getting customer feedback will be an important part of this pursuit. It pays to ask your customer what price point would justify another purchase.
Can Marginal Benefit Change?
Marginal benefit tends to decrease as the customer purchases more of the same product or service. This is called the “law of diminishing marginal utility,” which also refers to when a consumer becomes less willing to buy goods at their original price after their first purchase.
This concept plays a big role in your business’s pricing policy. The price in the unit must always be equal to the customer’s willingness to buy an item, as well as their marginal benefit.
As much as you want customers to keep buying your products and services, it’s not a realistic scenario. Price will always play a role in the customers’ willingness to buy the same goods. So use the marginal benefit to your advantage to strike a balance between pleasing customers and making a profit.