Introduction to Incremental Analysis

Incremental analysis in economics is also one of the tools used in rational decision-making like marginal analysis and is used in different economic concepts like profit, cost, revenue, utility, etc. Increment simply refers to a change in total. Marginal analysis sometimes may not be applied in real-life especially when it is not possible to determine the marginal cost and marginal revenues for the next unit of production. At such time, incremental analysis is used to decide by the economic agents.

Marginal analysis is based on one unit change or very small change in terms of derivative while the incremental analysis is based on the change in total (broader scope). In the incremental analysis, change in the total cost and total revenue is measured like the measurement of MC and MR in the marginal analysis. Then, TC is compared with TR to decide by economic agents.

Incremental analysis is therefore a cost approach widely used in short-term financial decision-making. For example, ABC factory decides to install a new plant. As a result, the total cost increases from Rs. 150 crores to Rs. 165 crores. Here the incremental cost is Rs. 15 crores. On the other hand, total revenue increased from Rs. 180 crore to Rs. 200 crore due to the installation of a new plant (Increase in production and sales). Hence the incremental revenue is Rs. 20 crores.  Here, incremental revenue is greater than the incremental cost, so it is a wise decision to install a new plant. Therefore, the incremental analysis gives the base for purchase decisions and marginal analysis gives the base for optimization decisions.

Example of Use of Incremental Analysis in Economics

Let’s take an example: CG Company produces 100,000 units of shaving machines. For this, it makes shaving razors which costs Rs.5 per unit of variable cost and total fixed cost is Rs. 450,000. But if it buys, it costs Rs. 10 per unit. What will be a profitable move? Make or buy?

Let’s see: The Case

Cost	Make	Buy	Net Income Comparison
Fixed Cost	450,000	0	450,000
Variable Cost	5*100,000=500,000	0	500,000
Buy	0	10*100,000=Rs. 1000,000	(1000,000)
Total Cost	Rs. 950,000	Rs. 1000,000	(Rs,50,000)

The above illustration shows that the total cost of ‘make’ of the razor blade is Rs. 950,000 whereas the total cost of ‘buy’ is Rs. 1000,000. So, it is expensive Rs. 50,000 to buy razor blades from other suppliers. But if we consider the opportunity cost of factory building and land, the decision may be different. If the factory space and plant are used for the other purpose, let’s say it yields Rs. 200,000. This is the opportunity cost of the factory area.

Now, the total cost of ‘make’= Rs. 950,000 and the total cost of ‘buy’= Rs. (1000, 000-200,000) = Rs. 800,000. So, the cost difference between ‘make’ and ‘buy’ is Rs. 150,000.

In the incremental analysis, we have to consider the relevant cost and revenue. So, if the company decides to buy the razor blades, it can save Rs. 150,000 as compared to manufacturing them. So, at the time of decision making only relevant costs and revenue are considered. Irrelevant and sunk costs and revenue are ignored.

Comparison between Marginal Analysis and Incremental Analysis

The comparison between marginal and incremental analysis in economics includes both similarities and differences between the tools of decision-making.

Similarities

Marginal analysis and incremental analysis are two approaches used in problem-solving and decision-making in economics. Both tools can apply to different economic variables like cost, revenue, production, utility, etc. Both the approaches analyze based on the change in economic variables.  

Differences

Basis	Marginal Analysis	Incremental Analysis
Meaning	Analysis based on per unit change.	The analysis is based on the change in total.
Use	Widely used in the efficient allocation of recourses in economies.	Widely used by business decision-makers, especially in investment decisions in business economics.
Function	It is used in maximizing/minimizing decisions like identifying profit-maximizing output etc.	Used to select the best option among different alternatives like change in firms volume of output, introducing a new product, etc.
Decision making	Examines the marginal cost and marginal revenue of a specific variable.	Examines the total cost and total revenue to take a decision.
Types of costs considered	Primarily considers all the costs. It means it may include opportunity cost and sunk cost both.	It takes into consideration opportunity costs and relevant costs. It eliminates all the sunk costs.

Conclusion

Marginal and incremental both are techniques applicable in problem-solving and decision-making. The marginal analysis primarily focuses on assessing the impact of the unit change of a given variable under the study. Decision-makers or economic agents use the concept of marginal analysis while forming optimization decisions. And incremental analysis is also a decision-making tool that is used to determine true cost-effective alternatives among the given set of possible alternatives. Therefore, both the analyses in economics are highly useful tools.

References and Suggested Readings

Dhakal, R. (2019). Microeconomics for Business. Kathmandu: Samjhana Publication Pvt. Ltd.

Shrestha, P.P. and et.al. (2019). Microeconomics for Business. Kathmandu: Advance Sarswati Prakashan.