Marginal Cost: Definition, Equation & Formula
Marginal cost is an important concept in business. In this lesson, you’ll learn what marginal costs are and their standard formula with some illustrative examples. A short quiz follows the lesson.
Key Concepts of Marginal Costs
Marginal cost is the increase or decrease in the total cost a business will incur by producing one more unit of a product or serving one more customer. If you plot marginal costs on a graph, you will usually see a U-shaped curve where costs start high but go down as production increases, but then rise again after some point. For example, in most manufacturing endeavors, the marginal costs of production decreases as the volume of output increases because of economies of scale. Costs are lower because you can take advantage of discounts for bulk purchases of raw materials, make full use of machinery, and engage specialized labor.
However, production will reach a point where diseconomies of scale will enter the picture and marginal costs will begin to rise again. Costs may rise because you have to hire more management, buy more equipment, or because you have tapped out your local source of raw materials, causing you to spend more money to obtain the resources.
Marginal cost graph
You can use marginal costs for production decisions. If the price you charge for a product is greater than the marginal cost, then revenue will be greater than the added cost and it makes sense to continue production. However, if the price charged is less than the marginal cost, then you will lose money and production should not expand.
Formula for Marginal Cost
The formula for marginal costs can be expressed as follows:
Marginal Cost = Change in costs / Change in quantity
For the more algebraically inclined, marginal cost can be also be expressed by this equation:
Marginal Cost Formula
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