Marginal Cost

What is it ?

Marginal cost is a term used to describe the change in total costs of production resulting from the addition of one item. It can also be seen as the avoidable cost of not producing an additional item. It is usual to look at short term marginal cost, which is an additional cost when only some of the costs of production can be varied. Long term or more commonly known as long run marginal cost is the change in cost when all input costs can be varied.

It is closely related to marginal cost pricing, in which prices are set at an amount equal to the marginal cost.

How is it used ?

It can be used by organisations in planning production and services and to determine whether to increase production or the level of service based on the associated increase in costs of the additional items.

Advantages and disadvantages

Use of marginal costing can quickly show the effect of increasing production and service levels. It is something that could be used more effectively in the public sector when planning the provision of eg. schools, hospitals and other infrastructure products. Examples of where it is not used effectively can be seen where, often due to short term planning horizons and lack of vision, inadequate public services are provided and have to be added to at later dates when the additional cost is much higher than the marginal cost would have been if the project was all completed at beginning. Eg, building a school with sufficient classrooms that only takes account of existing numbers rather than expectations and projections several years ahead.

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