Overhead Costs vs. Marginal Costs
revisiting a post from July 2023
If you were not a subscriber in July 2023, then I recommend my essay The Marginal Revolution is Dead. It argues that many businesses today have to think in terms of overhead costs, not marginal costs.
Organization capital is produced in “lumps,” not in discrete measurable units suited to marginalist calculations. Moreover, it is produced by teams, not by individuals. There is no sense in which a firm can measure the marginal product of a tax accountant or the marginal contribution to a product enhancement of a member of the team working on the project.
Read the rest.
In my view your essay missed the mark. In its simplest form, marginalism assumes that arbitrage is sufficiently strong to prevent price discrimination in the market. Where price discrimination is possible, the concept of the margin still applies, but there are multiple markets. Also, don't confuse marginal cost, a more subjective concept, with variable cost, a more engineering-type concept.
It is not really so hard to make judgments about the productivity of members of a team. You can add or drop team members and see what difference it makes. You can establish measurements that, as you have stressed, will eventually be gamed, but still beat a manager's gut feeling. Also, the market provides a rough way to gauge the value added by a team and its individual members: would it be cheaper to pay outsiders to produce this part / take care of the payroll / clean the premises / etc.?
This is a fine note about the overhead costs are more important to many businesses and are greater than the academic status currently given them -- with too much focus on MC.
However, for most businesses, like food, the pricing problem is not so big. Look at the competition, price about the same, get sales feedback that the price is too high (not enough sales) or too low (selling faster than expected; sometimes sold out).
Tho this ignores the quality aspect.
A major business decision involves the introduction of a new product, or investment in R&D, or salary increases. Such decisions with limited org funds always requires not spending money on some thing the org would like to spend money on. The investment marginal project not taken because of lack of funds. This is important because, if there is a Tax Cut shock, and more funds, these companies can often immediately do the marginal investment, which immediately increases economic production. A reason tax cuts do far more to stimulate the economy than similar monetary added spending.