Marginal Cost

Marginal cost shows how total cost changes as output changes by a single unit. It is calculated by dividing the change in total cost by the change in quantity.

For example, if producing 100 units costs 1,000 in total and producing 101 units costs 1,008, the marginal cost of the 101st unit is 8.

Marginal cost usually consists mainly of variable costs, such as materials and energy, because fixed costs do not change when one more unit is made. It may fall at first as production becomes more efficient, then rise as a business approaches its capacity, when overtime, extra shifts or less efficient equipment are needed.

Marginal cost is central to economic decisions. A business maximises profit by producing up to the point where the revenue from selling one more unit, its marginal revenue, equals its marginal cost. Producing beyond that point would add more to costs than to revenue.

In competitive markets, prices tend towards the marginal cost of production. This helps explain why digital products, which have marginal costs close to zero, can often be offered very cheaply or even free.