Marginal cost can be worked out in a really simple way. Marginal cost equals the total cost divided by the change in quantity. To get the total cost you need to add the fixed costs and the variable costs together.
Marginal cost is an economical and financial term. It is also known as 'choice cost', 'incremental cost', or 'differential cost'. It refers to the short-term variable cost of either increasing production of a unit - either in small or larger quantities - or due to an increase in the production costs due to a rise in the price of raw materials, or even due to a decline in demand. If the demand goes down your revenue decreases, yet you're still paying all your employees so you're operating at increased cost.
- Can you give me an example?
Imagine that a factory is producing 100 toy cars. As it is a sizable order, and a specific figure, a bulk order fee can be worked out, as can the production costs in terms of material and labor. However, if you add an extra car on then that's not part of a bulk order; it's a separate production. That production will cost the normal rate to produce, not the discounted bulk order rate, and also mean that someone - or multiple staff - have to work a little extra, incurring overtime rates.
- Why is marginal cost significant?
Marginal cost is significant because it's vital in relation to resource allocation. In order to balance the books correctly, and not overspend at a time of limited resources, the management - specifically those allocating funds - have to counter the marginal cost rises. These can be many, so they have to work out the correct ratio of funds to go where. A mistake in the calculations and it could see one area of the business under funded, or seemingly under-performing, or even worse see that area of the business cease productivity.
