Marginal (Incremental) Cost – Explanation, Examples, Formula

Marginal (Incremental) Cost Definition

Marginal (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/marginal 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 Marginal (Incremental) Cost

The incremental/marginal 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 marginal profit.

Ex: Assume that an oil purifying company has a marginal/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, incremental/marginal 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.

Marginal (Incremental) Cost Examples

Following are some examples of Incremental/Marginal 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.

Marginal (Incremental) Cost Formula

Following is the Formula to Calculate Marginal (Incremental) Cost,

Marginal (Incremental) Cost Per Unit = Variable Cost / Units Produced

Marginal (Incremental) Cost of Additional Units = Marginal (Incremental) Cost Per Unit x Additional Units Produced

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