Marginal Cost Definition & Formula

The marginal cost formula helps calculate the value of the increase or decrease of the total production cost of the company during the period under consideration if there is a change in output by one extra unit and is calculated by dividing the change in the costs by the change in quantity.

Marginal cost is the change in the total cost of production upon a change in output that is the change in the quantity of production. In short, the change in total cost arises when the quantity produced changes by one unit. Mathematically, it is expressed as a derivative of the total cost concerning quantity.

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where,

  • Change in Total Cost = Total Cost of Production including additional unit – Total Cost of Production of a normal unitChange in Quantity = Total quantity product including additional unit – Total quantity product of normal unit

How to Calculate Marginal Cost? (Step by Step)

Example

  • Consider the total output, fixed cost, variable cost, and total cost as input. Prepare a production graph considering a different quantity of output. Find the change in cost i.e., a difference in the total cost of production, including additional unit and total cost of production of the normal unit. Find the change in quantity, i.e., total quantity product, including additional unit and total quantity product of normal unit. Now, as per the formula of Marginal cost, divide change in cost by a change in quantity, and we will get marginal cost.

Here,

  • Change in Total cost = $1,25,000 – $1,00,000 = $25,000Change in Quantity = 2000 – 1000 = 1000

Now,

  • Marginal Cost = 25000/1000 = 25

Marginal Cost Formula in Excel (with excel template)

Now let us take the case mentioned in the above example to illustrate the same example in the excel template below.

In below template is the data of the manufacturing company for the calculation.

So the total calculation of marginal cost will be-

Marginal Cost Calculator

You can use the following Calculator.

Uses and Relevance

  • The marginal cost formula is used in financial modelingFinancial ModelingFinancial modeling refers to the use of excel-based models to reflect a company’s projected financial performance. Such models represent the financial situation by taking into account risks and future assumptions, which are critical for making significant decisions in the future, such as raising capital or valuing a business, and interpreting their impact.read more to optimize cash flow generation.It is used to calculate the incremental costIncremental CostIncremental costs are the additional costs associated with the production of one additional unit, and it only considers costs that are likely to change as a result of a specific decision, such as replacing machinery or equipment or adding a new product, and so on.read more of production.It helps to make production decisions.

The marginal cost at each production level includes additional costs required to produce the unit of product. Practically, analyses are segregated into short-term, long-term, and longest-term. At each level of production and period being considered, it includes all costs that vary with the production level. Other costs are considered fixed costs, whereas practically, there is inflation, which affects the cost in the long run and may increase in the future.

Several factors affect the marginal cost and application. Some of them are considered a market failureMarket FailureMarket failure in economics is defined as a situation when a faulty allocation of resources in a market. It is triggered when there is an acute mismatch between supply and demand. As a result, prices do not match reality or when individual interests are not aligned with collective interests.read more. It also includes information asymmetries, the presence of externalities, transaction costs, etc.

Marginal cost can be said as an extra expense on producing one additional unit. It helps management make the best decision for the company and utilize its resources in a better and more profitable way, as with quantity, profit increases if the price is higher than this cost.

This article has been a guide to the Marginal Cost Formula and its definition. Here we learn how to calculate the marginal cost and its uses along with practical examples. You can learn more about Accounting from the following articles –

  • Meaning of Variable CostingExamples of Variable Costing Income StatementFormula for Variable CostingWhat are Direct Costs?What Are Direct Costs?Direct cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. Such costs can be determined by identifying the expenditure on cost objects.read moreSingle Step Income StatementSingle Step Income StatementThe Single Step Income Statement is a format for Income Statement that records all expenses in one column, i.e., it lists the cost of goods sold with the operating, non-operating, and other business expenses.read more