Marginal Costs
- The cost added by producing one additional unit of a product or service.
- A fundamental concept in microeconomics used to determine the most efficient level of production, calculated by dividing the change in total cost by the change in the quantity produced.
Simple Version
Imagine you are baking cookies. You have already paid for the oven and the bowls. The marginal cost is simply the cost of the extra flour, sugar, and chocolate chips needed to make just one more cookie.
Example
If a factory spends 1,015 to produce 101 chairs, the marginal cost of the 101st chair is $15.
Real World
For software companies, the marginal cost of a new user is often near zero. Once the software is built and the servers are running, sending the code to one more person costs almost nothing, which allows these companies to scale very quickly compared to a car manufacturer.
Synonyms
- Similar: Incremental cost, differential cost, variable cost, step cost, additional cost
Etymology
- The term “marginal” comes from the Latin margo (“edge” or “border”). In an economic sense, it refers to the “edge” of production—the very last unit produced. The concept was popularized during the “Marginal Revolution” in economics during the late 19th century.
Frequently Asked Questions
How does the law of diminishing returns affect marginal costs?
As production increases, there often comes a point where adding more resources (like labor) to a fixed space (like a factory) results in smaller increases in output. This causes the marginal cost to start rising because it becomes more expensive to produce each additional unit.
What is the difference between marginal cost and fixed cost?
Fixed costs (like rent or insurance) remain the same regardless of how much you produce. Marginal costs, however, are primarily composed of variable costs (like raw materials and direct labor) that change specifically because you are producing more units.
At what point is profit maximized in relation to marginal cost?
In economic theory, a firm maximizes its profit by producing up to the point where the marginal cost of the last unit produced is exactly equal to the marginal revenue (the money earned from selling that unit).