Marginal cost: what it is and how it calculates

Marginal cost is a concept used in economics and seeks to describe the  changes caused in the total cost of a unit change in the quantity produced  .

Since the marginal cost is higher, it means that a higher proportion has been added to the total costs. If there is a decrease in marginal cost, total costs will grow at lower and lower rates.

Marginal cost analysis is important to understand how costs grow as a company wants to produce more. After a certain point, and depending on the technology used, increasing quantities requires an incremental increase in costs.

Also, with an increase in production, it is possible to compare the increase in revenue with the additional quantity to be sold, in this case known as marginal revenue.

The activity may be viable if the variation in the returns obtained is greater than or equal to the variation in costs, through marginal cost.

The marginal cost can be compared to the average cost for a certain level of production. The average of a cost is measured by the total cost divided by the quantity.

Marginal cost calculation

The marginal cost calculation can be done by varying the total cost by the added quantity. The variation of the total total cost (TC), less the previous one, is measured with the variation of the quantity (Q).

In the case that a function is analyzed, the infinitesimal calculation is performed using the derivative in order of the added quantity:

This is how you find the necessary increase in costs to produce more. Otherwise, measure what is saved by reducing the amount.

Example

For a product that is sold each for R $ 50 in the market, a company has a different total cost as the quantity produced increases, with the machinery it has available.

For each quantity produced, the costs incurred and the billing at each level can be seen in the table below:

QuantityTotal cost (R $)Total income (R $)Total profit (R $)Marginal cost (R $)Average cost (R $)
0 0fifty0 0-fifty
190fifty-404090.00
two120100-twenty3060.00
314015010twenty46.67
4 4170200303042.50
5 5210250404042.00
6 626030040fifty43.33
7 73203503060 6045.71
84004000 08050.00

The lowest marginal cost is found in the variation of the quantity from 2 to 3 units. In this case, the increase in cost is less, in addition to the fact that the company begins to make a profit.

If the increase is made from 2 to 4 units, the total cost would go from R $ 120 to R $ 170. The marginal cost is calculated as:

  • CMg = (170-120) ÷ (4-2)
  • CMg = 50 ÷ 2 = $ 25

This means that, for each of the 2 units added, the company would assume an additional cost of R $ 25 each.

Difference between marginal cost and average cost

Although marginal cost is related to additional cost borne, average cost is a measure of cost per unit produced.

Average cost may be decreasing as it is calculated with larger quantities. When this happens for a company, it is said to produce at an economy of scale.

However, the steady increase in the average cost of large quantities is said to be the company producing diseconomies at scale. If the company wants to produce more, it will incur a higher cost per unit.

In economics, when average cost and marginal cost are analyzed in the long run, it is considered that the firm can change the costs of its factors of production.

In this case, it can be represented on a graph where the marginal cost curve is equal to the point where the lowest average cost exists:

From the marginal cost curve, it is possible to see that, at a certain point, there will always be an increase in costs as the company produces a larger quantity.

This effect is associated with the Law of Diminishing Marginal Returns, in which adding additional units of factors of production does not increase productivity, making production more expensive.

Marginal cost and marginal revenue

When analyzing the level of a production, the income that the product or service offers to the company can be considered.

With a larger quantity, it is possible to increase revenues but also costs, given the limitations of production.

The concept of marginal income considers the additional income for the company with an increase in production, in an analysis similar to that of marginal cost.

In the example calculated above, revenue is constantly growing at the value of the price for each quantity sold.

Marginal revenue can be seen as the added benefit of having produced one more unit. There are situations where marginal revenue increases, while additional cost increases.

For an activity to be viable, it is possible to maximize profits to the point where the benefits and additional costs are equal.