Marginal cost
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In economics and finance, marginal cost is the increase in total cost that arises when the quantity produced (or purchased) increases by one unit.
The use of this term usually implies that the cost per unit depends on the total number of units produced. For example, the marginal cost to go from producing 0 cars to producing 1 car is tremendous. The marginal cost at 100 cars—that is, the cost of producing the 101st car—is much lower, and the marginal cost at 10,000 cars is lower still (due to economies of scale).
However, when one factors in opportunity cost, it is possible for the marginal cost to increase with the total number of units produced. The resources used to produce extra cars (in this example) may be better spent elsewhere -- on endeavors with increasing marginal benefit as less resources are spent on them and more on producing cars.
Marginal cost is not the same as average unit cost. The average unit cost considers the cost of every unit. The marginal cost ignores all units except the last. For example, the average cost per car includes the heavy fixed cost to produce the first car (divided among all the cars produced). The marginal cost does not include that fixed cost at all.
Marginal cost pricing is the business strategy of selling produced items at their marginal cost. The idea is the marginal cost is the lowest price at which goods can be sold to keep the business "ticking over" in difficult economic conditions. Since the fixed costs are likely already sunk, marginal cost pricing should, in theory, allow the company to continue functioning without making a loss.
Other cost definitions
- Fixed costs are costs which do not vary with output, for example, rent. In the long run all costs can be considered variable.
- Variable cost also known as, operating costs, prime costs, on costs and direct costs, are costs which vary directly with the rate of output, for example, labour, fuel, power and cost of raw material.
- Average total cost is the total cost divided by the quantity of output.
- Average fixed cost is the fixed cost divided by the quantity of output.
- Average variable cost are variable costs divided by the quantity of output.