Incremental Cost – Explanation, Examples, Formula

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Incremental Cost Definition

Incremental cost is the cost incurred due to an additional unit of a product being produced. This is the increase/decrease in the cost of producing one more additional unit or serving one more additional customer.

The incremental cost is the cost involved to make an additional unit of product. That also means the additional cost incurred by a company if it produces one extra unit of output.

Importance of Incremental Cost

The incremental cost is important to make product pricing decisions. The company management can consider the cost of producing one additional unit to make their pricing decisions to make a profit.

Ex: Assume that an oil purifying company has an incremental cost of $20 to produce 1-liter oil purification. The company should price their service for 1-liter for more than $20, which also considering the fixed cost.

Also, the incremental cost is important to choose whether to make or buy. Assume a car manufacturing company needs an airbag sensor as an item for manufacturing. The company can choose whether it is less costly to make the sensor in-house, or else buy that from an external supplier.

Incremental Cost Examples

Following are some examples of Incremental Costs,

  1. Raw Materials such as Inventory – Cost to buy one additional raw material.
  2. Utilities, such as Water – Water consumption costs to produce one additional product.
  3. Wages / Salaries – Cost of additional wages/salaries to pay to produce one additional product.
  4. Utilities, such as Electricity – Electricity costs to produce one additional product.

Incremental Cost Formula

Following is the Formula to Calculate Incremental Cost,

Incremental Cost Per Unit = Variable Cost / Units Produced

Incremental Cost of Additional Units = Incremental Cost Per Unit x Additional Units Produced

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