What is Marginal Cost ? | Formula, Example and Graph

What is Marginal Cost?

The additional cost incurred to the total cost when one more unit of output is produced is known as Marginal Cost. Marginal Cost is also known as Incremental Cost. Marginal Cost can be used to determine the optimal production volume and pricing. It includes both variable costs (such as labour, material, etc.) and fixed costs (such as selling cost, administrative cost, overhead cost, etc.)

For example, if the total cost of producing 2 units is ₹400 and the total cost of producing 3 units is ₹600, then the marginal cost will be 600 – 400 = ₹200.

MC_n = TC_n – TC_n-1

Where,

n = Number of units produced

MC_n = Marginal cost of the n^th unit

TC_n = Total cost of n units

TC_n-1 = Total cost of (n-1) units

Another way to calculate Marginal Cost

When the change in the units produced is more than one unit, then the previous formula of calculating MC will not work. In that case, the formula for calculating Marginal Cost will be:

For example, if the total cost of producing 5 units is ₹700 and the total cost of producing 3 units is ₹250, then the marginal cost will be:

Marginal Cost = ₹225

Marginal Cost is affected by Fixed Costs

Marginal Cost is the additional cost to Total Cost when one more unit of the output is produced. Also, TC is the sum of TFC and TVC. Now, as TFC does not change with the change in output, Marginal Cost is independent of Total Fixed Cost and is affected by TVC only.

The following mathematical derivation can easily explain this concept: 

MC_n = TC_n – TC_n-1 ……….(1)

TC = TFC + TVC …………..(2)

Now, by putting the value of (2) in (1), we get

MC_n = (TFC_n + TVC_n) – (TFC_n-1 + TVC_n-1)

= TFC_n – TFC_n-1  + TVC_n – TVC_n-1 ………….(3)

As TFC is same at all output levels, TFC_n = TFC_n-1

Therefore, (3) becomes

MC_n = TVC_n – TVC_n-1 

Example:

In the above schedule, MC is determined in two ways; using TC and TVC.

In the above graph, the MC curve is formed by plotting the points shown in the above schedule. MC is a U-shaped curve because of the Law of Variable Proportions. In the beginning, the units of the variable factor are employed along with the fixed factors, yielding increasing returns to factor and reducing MC. It pushes down the MC curve. Now, when more variable factors are employed, it results in diminishing returns and increasing MC after it reaches its minimum level. Therefore, the MC curve falls to its minimum level and then increases, making the short-run MC curve, U-shaped.