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Marginal cost is a metric that looks at the additional costs involved in producing one unit of a good or service. Understanding marginal costs helps with sound financial management and assists businesses in deciding the profitability of both increased and decreased production.
Marginal cost (definition)
Marginal cost is a concept in economics that refers to the additional cost incurred by producing one more unit of a good or service. Both fixed costs and variable costs are considered when looking at marginal costs.
Marginal costs basically represent the change in total cost that results from a one-unit change in the level of production.
Marginal cost calculations can help businesses when making production decisions or pricing strategies in the short term, as they provide insight into whether it’s profitable to increase or decrease production.
In ideal market conditions, businesses usually set their prices equal to their marginal costs to maximise long-term profit.
How do you calculate marginal cost?
The marginal cost equation and steps are as follows:
- Determine the Change in Total Cost
Find out how much the total cost increases or decreases when you produce one more unit. - Determine the Change in Quantity Produced
Identify the change in the quantity of goods or services produced when moving from one production level to another.
In calculating marginal cost, you can now simply divide the change in total cost by the change in quantity produced.
Use the marginal cost formula:
Marginal cost = Change in Total Expenses / Change in Quantity of Units Produced.
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