Definition of Marginal Cost
Marginal cost is a manufacturer’s cost to produce one more unit of product. In other words, marginal cost is the change in total costs when one additional unit is produced. The marginal income tax cost (or tax rate) is the income tax cost of earning the next dollar of taxable income.
The marginal cost is important because a company’s fixed costs are unlikely to change when one more unit is produced or one additional unit of activity takes place. Therefore, the marginal cost is typically less than the average cost.
Example of Marginal Cost
Assume that a company’s total cost of producing 10,000 units of product is $50,000. When the company produces 10,001 units, the company’s total cost is $50,002. Therefore, the marginal cost of producing unit #10,001 is $2.
The reason that the marginal cost was $2 instead of the previous average cost of $5 ($50,000 divided by 10,000 units) is that some costs did not increase when the additional unit was produced. For example, fixed costs such as the actual salaries, depreciation, and property taxes are unlikely to increase because one more unit was produced.
