When performing financial analysis, it is important for management to evaluate the price of each good or service being offered to consumers, and marginal cost analysis is one factor to consider. Using this calculator will help you calculate the cost of the next unit, and decide if it is worth it to increase production. Once you choose to change your output, you may find it encouraging to calculate your new potential profit! This might lead to decisions that are profitable in the short term but can prove to be otherwise in the long run. The easiest way to understand marginal cost is to illustrate it with an example. Let’s look at how companies can use marginal costs in a manufacturing environment.
The quicker you can reach an optimum production level, the better for your business. Put simply, if the marginal cost of producing one additional unit is lower than the purchase price, the company can make a profit. The breakdown of total costs into fixed and variable costs can provide a basis for other insights as well. The first five columns of Table 7.10 duplicate the previous table, but the last three columns show average total costs, average variable costs, and marginal costs. These new measures analyze costs on a per-unit (rather than a total) basis and are reflected in the curves in Figure 7.8.
Units of production
You can see from the graph that once production starts, total costs and variable costs rise. While variable costs may initially increase at a decreasing rate, at some point they begin increasing at an increasing rate. This is caused by diminishing marginal productivity which we discussed earlier in the Production in the Short Run section of this chapter, which is easiest to see with an example.
In this example, the marginal cost of each of these units would equal $3. When marginal costs are declining, it means that the company is reducing its average cost per unit because of economies of scale or learning curve benefits. At a certain level of production, calculate marginal cost the benefit of producing one additional unit and generating revenue from that item will bring the overall cost of producing the product line down. The key to optimizing manufacturing costs is to find that point or level as quickly as possible.
What is the Formula for Marginal Cost?
The marginal cost curve is generally upward-sloping, because diminishing marginal returns implies that additional units are more costly to produce. We can see small range of increasing marginal returns in the figure as a dip in the marginal cost curve before it starts rising. There is a point at which marginal and average costs meet, as the following Clear it Up feature discusses. Average total cost (sometimes referred to simply as average cost) is total cost divided by the quantity of output. Since the total cost of producing 40 haircuts is $320, the average total cost for producing each of 40 haircuts is $320/40, or $8 per haircut. Average total cost starts off relatively high, because at low levels of output total costs are dominated by the fixed cost.