What Is Marginal Cost? Definition and Calculation Guide

what is marginal cost

Marginal cost refers to the increase or decrease in the cost of producing one more unit or serving one more customer. It is also known as incremental cost.

Marginal costs are based on production expenses that are variable or direct—labor, materials, and equipment, for example—not on fixed costs the company will have whether it increases production or not. Fixed costs might include administrative overhead and marketing efforts—expenses that are the same no matter how many pieces are produced.

It is often calculated when enough items have been produced to cover the fixed costs and production is at a break-even point, where the only expenses going forward are variable or direct costs.

When average costs are constant, as opposed to situations where material costs fluctuate because of scarcity issues, marginal cost is usually the same as average cost.

Calculating marginal cost

Calculating the marginal cost helps a business determine the point at which increasing the number of items produced will push the average cost up. Costs can increase if production volume requires the company to add equipment, move to a larger facility, find a another supplier that can provide enough materials.

For example, if a company can produce 200 units at a total cost of $2,000 and producing 201 costs $2,020, the average cost per unit is $10, and the marginal cost of the 201st unit is $20.

Here’s the formula for calculating marginal cost: Divide the change in total costs by the change in quantity. Using the example above, the change in cost is 20 and the change in quantity is 1. 20 divided by 1 equals 20.

When charted on a graph, marginal cost tends to follow a U shape. Costs start out high until production hits the break-even point when fixed costs are covered. It stays at that low point for a period, and then starts to creep up as increased production requires spending money for more employees, equipment, and so on.

Understanding a product’s marginal cost helps a company assess its profitability and make informed decisions related to the product, including pricing

Marginal Cost FAQ

What do you mean by marginal cost?

Marginal cost is the additional cost incurred for producing one more unit of a good or service. It is the incremental cost of producing one more unit of a good or service, usually expressed as the cost per unit of output. It is calculated by taking the total cost of production and dividing it by the number of units produced.

What is marginal cost and example?

Marginal cost is the cost of producing one additional unit of a good or service. An example of this would be the cost of an additional hour of labor or the cost of an extra machine to increase production.

What is a marginal cost formula?

Marginal Cost Formula: Marginal Cost = Change in Total Cost / Change in Quantity

What is the difference between cost and marginal cost?

Cost refers to the total amount of money spent to produce a certain quantity of a product or service. Marginal cost is the cost associated with producing one additional unit of a product or service. It is calculated by taking the total cost of producing a certain quantity and subtracting the cost of producing the previous quantity.