Producing a product requires a firm to make several decisions. These include how much labor and capital will be devoted to the production process, what level of quality is required, and how much product should be produced in order to maximize profit.
One important factor that contributes to the profitability of a given product is marginal cost. Marginal cost gives an idea of the total cost of a product at a certain stage of production. It helps to set up the production level to maximize profit. In this article, we will be looking at what marginal cost is, how to calculate it, and some examples.
What is Marginal Cost
In economics, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. It is also known as incremental cost or differential cost. Marginal costs basically come from the production of one more unit.
It is the cost of producing one extra item or an additional item to a group of items. For example, if 5 pens are being produced, the marginal cost will be the expense of producing the 6th pen. Marginal cost can also refer to serving customers as well.
Importance of Marginal Cost
Marginal cost is an important factor when it comes to making decisions related to production. It helps the firm decide how much product should be produced in order to maximize profit. This is because marginal cost provides information about the additional costs of producing another unit, e.g., raw material costs or labor costs.
It is one of the most integral concepts in economic analysis. It is a very real cost associated with the production of a good or service, which has to be considered during business decision-making.
How to Calculate Marginal Cost
In order to calculate marginal cost, you will need two things
- Change in total cost: This is the difference between the total cost of production before and after producing extra units.
- Change in quantity produced: This is the amount that you are increasing or decreasing your production by, e.g., 2 units or 1 unit
The formula of marginal cost
Marginal cost is calculated as follows,
Marginal Cost = Change in total cost/Change in quantity produced
As you can see it is not that difficult at all. All you need is the difference in total cost and change in quantity produced, and you can easily calculate the marginal cost.
Marginal Cost Example
Let’s say that you own a car manufacturing company. This is your first year and you have manufactured 10 cars for $100,000, which cost you $50,000 to make. So the next year you change your plans and want to manufacture 15 cars for $150,000, which will cost you $75,000.
So what will be your marginal cost for this year?
Marginal Cost = Change in total cost/Change in quantity produced
= $25,000/5
So your marginal cost will be $5,000
Conclusion
Marginal cost is indeed an important factor for any company that offers goods and services. It helps a firm decide what level of production it should achieve to maximize the profit they make. It provides information about the additional costs of producing another unit, e.g., raw material costs or labor costs. The formula is not hard at all and once you have understood the concept, you’ll find it very easy to apply in several situations.
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