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5.3: Marginal Cost

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    When it comes to production costs, a manager must consider three things:

    • total costs
    • average total costs
    • marginal costs

    Total cost is the value of all the inputs and effort required to bring a good or service to market.

    Average total cost is the total cost (i.e., sum of all the production costs) divided by the number of units produced. This statistic will show the manager what a typical unit costs the company. Now, some units cost more to produce, and some cost less so average cost is not an exact per unit measurement.

    Marginal cost is the change in total cost when output is increased. So, if a manager decides to increase output by one unit and total cost rises from $5,000 to $5,350, then marginal cost is $350.

    We are going to focus on marginal costs.

    Basically, a marginal analysis is a “before and after” look at some process. Economists tend to prefer to conduct marginal analyses (as opposed to an average or total analyses) because it shows direction (i.e., up, down, constant).

    For example, what if I stated that the total value of U.S. output in 2023 was $14.3 trillion?

    A graph with a bar and textDescription automatically generated

    How much use is this data? Answer: Not much. Yes, $14.3 trillion does sound like a humongous number. But it is nearly meaningless without context. Now, what if I added that in 2022 output was valued at $30 trillion?

    A graph of a price chartDescription automatically generated with medium confidence

    Does this added information give the 2023 data more meaning? Absolutely. By conducting a simple marginal analysis, one realizes that the U.S. economy contracted by 52.3% (a fall of $15.7 trillion) in only one year! Without doing a “before and after” (i.e., marginal analysis) analysis this useful information would remain a secret.

    A very important question in business is how total cost is affected when production increases. A marginal analysis will help us find an answer.

    Marginal cost is the change in total cost when output increases.

    \[\mathrm{MC}=\Delta \mathrm{TC}^* / \Delta \mathrm{Q}^* \nonumber\]

    A business must look at the level of total cost before and after the production of, let’s say, one unit.

    Calculating \(\mathrm{MC}\) allows a business to measure how the production of the last unit of output will impact total cost (and ultimately, profits).

    *\(\Delta \) is the Greek letter delta means “change in”.

    This page titled 5.3: Marginal Cost is shared under a not declared license and was authored, remixed, and/or curated by Martin Medeiros.

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