Marginal Cost: Meaning with Example and Feature

Marginal Cost: Meaning with Example and Feature
Marginal Cost: Meaning with Example and Feature

Marginal Cost: In research, production, retail, accounting and other operating activities of an organisation, a cost stands as the value of money which has been incurred for producing something or delivering a service. Hence, the cost is a one-time element to be used and once it used for the first time, it becomes unavailable to use anymore. In businesses, the cost comes as an element used for acquiring something i.e. a particular amount of liquid cash spend for acquiring an asset or something else is treated as a cost. In this particular case, money acts as the input which is gone in the process of acquiring a tangible thing, sometimes intangible too. This type of acquisition cost refers as the sum of production cost which is incurred by a product’s original producer. Though a sum of money is incurred while acquiring an asset (income-generating asset), it is not treated as cost whereas it is treated as an expense. In more generalised term and considering the economics, cost refers to a metric which is totalling-up as a result of a particular process.

A particular amount that must be given up or paid for getting something tangible or intangible is called cost. In business operation, cost stands as a valuation, monetary in form, of effort, material, resources, utilities and time consumed, cash and risks incurred, as well as the opportunity gave up in the practice of production of products or services and its delivery. All kinds of expenses are treated as costs, but not all types of costs are considered as expenses. Cost or costs are often described on the basis of their applicability and timing. In accounting as well as in economics, there are a number of costs such as accounting cost, historical cost, opportunity cost, marginal cost, transaction cost, and sunk cost. All these costs are considered by businesses while computing cost of products, pricing of final products, profit from business and more. Moreover, these are also taken into account by a company’s management personnel while they tend to make business-related decisions. Our experts from Assignment Help will now explain you this with an infographic:

Marginal Cost
Marginal Cost

Meaning of Marginal Cost with Example

Marginal cost refers to the change in the total cost which comes from producing or making one more additional item. It is an additional cost a producer or manufacturer incurs for producing an additional unit of output. The marginal cost of production is analyses with the purpose of determining the exact point at which a company can achieve economies of scale. More specifically, the decrease or increase in a company’s total cost of production to make only one more i.e. an additional unit of a product is the marginal cost. Marginal cost is computed by a company when it becomes able to reach a break-even point where the total fixed costs are been absorbed by the items that are already produced and the direct or variable costs left for being accounted.

The calculation of marginal cost is done by applying the following formula –

Marginal Cost = Change in total cost / the change in output

Marginal costs elements are variable in nature, which consist of material costs, labour cost along with an estimated part of a company’s fixed costs related to its products such as selling expenses and administration overheads. In those companies, where average costs remain fairly constant i.e. almost fixed, marginal cost becomes equal to the average cost. Moreover, in heavy industries such as in automobile plants, mines, and airlines which require a large amount of capital investment and have huge average costs, marginal cost remains very low compared to other industries which are not involved or require large capital investments. The calculation of the marginal cost of production is mostly used by manufacturers in order to isolate an optimum level of production. It is often found, that manufacturers examine the costs of adding an additional unit to their existing production schedules. The reason behind this is, at some points of time, the benefit attached to the production of one extra unit of product or service and generating income from that extra item brings the total cost of production of the product-line down.

In production, marginal cost includes all kinds of costs which use to vary according to the level or unit of production. For instance, when a company tends to establish a new production unit or factory with the aim of producing more products, the cost incurred by the company for establishing the new factory is treated as marginal cost. Furthermore, the amount in relation to marginal cost uses to vary in accordance with the production volume that is being produced. There are a number of economic factors responsible for creating an impact on the marginal cost. These economic factors include information asymmetries, negative and positive externalities, price discrimination and transaction costs. Marginal cost of production is unrelated to a company’s fixed costs of production. In the economic theory, marginal cost is considered as an important factor because an organisation which is looking for maximising its profits needs to produce products up to the point of production where MC (marginal cost) becomes equal to MR (marginal revenue). Now our experts from Instant Assignment Help will give you some of the numeric examples of marginal cost.

Numeric Example of Marginal Cost

Marginal cost uses to indicate the rate at which the total cost of a particular product uses to changes according to the increase in production by a single unit. The amount of fixed cost attached to a product does not change on the basis of production volume or the number of items produced whereas marginal cost gets influenced by variable costs variations. Along with this, marginal cost is important to consider in the process of business-related decision-making. The management board of a company must consider the marginal cost of production for making decisions related to resource allocation in the best possible manner to ensure optimum resource utilisation through the company’s production process. For example, at the time when a company’s management board needs to make decisions on whether to increase the company’s current production volume or not, they need to compare marginal cost of production with marginal revenue (the revenue realised by an extra unit of production or output). 

A numeric example is provided below to illustrate the calculation of marginal cost in a better manner –

Quantity (Unit) Total Cost (Amount $) Marginal Cost (Amount $)
0 100 0
1 350 250
2 530 180
3 680 150
4 790 110
5 870 80
6 990 120
7 1140 150
8 1310 170

In the above table, it is found that for producing every single unit in additional, the marginal cost changes. Marginal cost stands nil when the number of unit produce stands 0 and after that when 1 unit produce marginal cost arise and it accounted for $250. Here, the marginal cost of $250 is computed by deducting the total cost of producing 0 unit (i.e. fixed cost) from the total cost of producing 1 unit i.e. $(350 – 100).

Observations gathered from the above numeric illustration:

  • The total cost of production increases in accordance with the production volume or the number of product increases. The reason behind this is the larger quantities a company produces, the greater the production factors it requires
  • Marginal cost is reduced up to a certain production level (in the example, at Quantity: 5 units), and after that, it starts growing according to the increasing volume of production
  • The marginal cost of manufacturing an extra unit of a particular product at every production level needs to consider a sudden increase in raw materials. Here, it is mentionable that if the company changes its raw material suppliers, the marginal cost might increase as a result of longer distances as well as the higher price of raw material.

Features of Marginal Cost

There are a number of features attached to marginal cost like –

  • It assists a company to gauge the impact of the different elements of variable cost on the production volume
  • All the cost elements are classified by considering the variability into variable cost and fixed cost. Costs that are semi-variable in nature are segregated into variable and fixed costs
  • Marginal cost i.e. variable cost is considered as the cost of a product/service
  • Stocks that include work-in-progress and finished goods are valued by considering marginal costs attached to them
  •  Break-even point is known as a part of marginal cost
  • The profitability of a company associated with a product is computed on the basis of contribution and contribution is computed by deducting the marginal cost of a product from the selling price of that product
  • Marginal cost helps in conducting cost-volume-profit (CVP) analysis

Advantages and Disadvantages of Marginal Cost

Advantages of marginal cost are –

  • The technique of identifying marginal cost element is easy and simple to understand because it does not include any complexity of apportioning fixed costs
  • It uses to avoid the carry-forward of a part of fixed overhead attached to the current period’s production cost to the next or subsequent period.
  • It makes cost comparisons more meaningful
  • Marginal cost uses to provide useful data and information to the management of a company in order to help it in managerial decision-making
  • It shows the fluctuation of sales and its impact on a company’s profit in a clear manner
  • The stock of work-in-progress and finished goods are valued by considering marginal cost remain uniform
  • It assists a company to make profit planning
  • It helps the management to find out both break-even point and break-even ratio
  • It helps the management of a company to gauge the different departments’ performance
  • It does not include any problem attached to under or over-absorption of production-oriented overhead costs
  • It helps management in budgetary control and standard costing
  • It uses to establish a clear and understandable relationship between sales, the volume of output, cost, and break­-even analysis

Disadvantages of marginal cost are –

  • Marginal cost is considered as a variable cost and segregation of a product’s production costs into variable and fixed elements involve technical difficulty which often leads a company to compute the marginal cost of a product inaccurately
  • Cost control can be done in a better way in standard costing or budgetary control
  • The practice of computing marginal cost is not been applied in contract costing because in contract costing the cost of work-in-progress always stands high
  • Pricing decisions are not been made only by considering marginal cost and contribution which is computed by deducting the marginal cost of a product from its selling price
  • Segregation of costs in variable and fixed cost become difficult in long-run which causes difficulties in computing the marginal cost

The Way Marginal Cost of Production Works

Production costs include fixed costs as well as variable costs. Here, variable cost stands as the costs elements that are required for producing every single unit of a product and fixed costs stand as the overhead costs which are distributed across the total unit of output. For instance, consider a shoemaker. For producing each pair of a shoe the show maker requires raw materials like fabric and plastic which costs $0.75 in total. The show maker incurs fixed costs of $100 per month. If the shoemaker makes 50 pair of shoe in every month, then the show maker needs to consider $2 ($100 / $50) as fixed costs per unit i.e. per pair of shoe. Here, the total cost per pair of shoe (including the cost of fabric and plastic) would be $2.75 [$0.75 + ($100/50)]. But if the shoemaker cranked up the production volume and starts producing 100 pair of shoe every month, then for per pair of a shoe the shoemaker will start incurring $1 as fixed costs. The reason behind this is that fixed costs are distributed across every unit of production. In this situation, the total cost per pair of shoe will drop and it becomes $1.75 [$0.75 + ($100/100)]. In this particular situation, by increasing the volume of production the shoemaker becomes able to reduce marginal costs of production. If you still want more help on this topic or any other topic related to any subject you can go to Homework Help UK.