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Difference Between Fixed Cost And Variable Cost
Marginal Cost
Semi Variable Costs
Variable Cost Examples

A Simple Guide to Marginal Cost

Marginal cost is defined as the total cost of one additional unit of production. In other words, when company output increases or decreases by one unit of goods (however that unit might be measured), the marginal rate goes up or down accordingly. These costs are essentially variable costs on a micro level.

Formula

A marginal expense is not exactly the price of making just the “next” unit, since the cost of all units is the same. Rather, it is the documented change in cost that arises with each unit of production, which often amounts to less than the cost of making an individual unit by itself. For example, the cost of making one chair might be $20 but the cost of making two chairs might be $30; thus, the marginal price of making the additional chair is actually $10.

Fluctuation

Because of their association with variable costs, marginal expenses can fluctuate according to a number of different factors. Most often, they will go up or down according to consumer demand and volume of production, but may also change with the prices of raw materials or wage labor costs. Both increases and decreases in marginal rates can signal an increase in production. For example, rates may rise as a result of paying employees overtime when production is already maximized, or they might decrease with the consumer price as production increases in a competitive market.

Increased Production Example

Imagine that the aforementioned chair company needed to manufacture more chairs, and thus spent more on the necessary raw materials, while all of its other expenses may remain the same. This would mean that the marginal cost would go down, because the same budget is being extended across more units of production. Alternately, if the chair company hired more employees to handle this increased production, marginal price would increase, because the additional units will now be expensed against costs that extend beyond just the raw materials.

Profit Maximization

Calculating marginal prices is an important component of planning and executing profit maximization within a company. Profit maximization occurs when marginal expenses are equal to marginal revenue (the money earned from selling one more unit of product). This is a difficult state to achieve, however, as marginal prices are constantly in a state of flux, with increases and decreases in demand controlling market and production prices. Changes in fixed costs, however, do not affect marginal costs.

Economies of Scale

Marginal expenses have been known to decline with “economies of scale,” or situations in which per-unit cost falls below average cost. Alternately, when marginal expense is higher than average expense (a situation caused by “diseconomies of scale”), per-unit prices increase and it becomes more difficult to maximize profit. Economies of scale often arise as a consequence of bulk buying and selling; while diseconomies of scale occur when a company moves closer to a contested monopoly.

The marginal cost also varies by industry. For instance, companies that require a lot of skilled individual labor, such as clothing companies whose products are stitched by hand, will likely have higher marginal rates than a company that mass-produces products on a large scale.