## What is 'Marginal Cost Of Production'

The marginal cost of production is the change in total cost that comes from making or producing one additional item. The purpose of analyzing marginal cost is to determine at what point an organization can achieve economies of scale.

Next Up

## BREAKING DOWN 'Marginal Cost Of Production'

The marginal cost of production calculation is most often used among manufacturers as a means of isolating an optimum production level. Manufacturers often examine the cost of adding one more unit to their production schedules. This is because at some point, the benefit of producing one additional unit and generating revenue from that item will bring the overall cost of producing the product line down. The key to optimizing manufacturing costs is to find that point or level as quickly as possible.

Marginal cost of production includes all of the costs that vary with the level of production. For example, if a company needs to build a new factory in order to produce more goods, the cost of building the factory is a marginal cost. The amount of marginal cost varies according to the volume of the good being produced. Economic factors that impact the marginal cost include information asymmetries, positive and negative externalities, transaction costs, and price discrimination. Marginal cost is not related to fixed costs.

Marginal cost is an important factor in economic theory because a company that is looking to maximize its profits will produce up to the point where marginal cost (MC) equals marginal revenue (MR).

## How Marginal Cost of Production Works

Production costs consist of fixed costs and variable costs. Variable cost refers to the costs required for each unit of output. Fixed costs refer to overhead costs that are spread out across units of output.

For example, consider a hatmaker. Each hat produced requires seventy-five cents of plastic and fabric. Your hat factory incurs \$100 dollars of fixed costs per month. If you make 50 hats per month, then each hat incurs \$2 of fixed costs. In this simple example, the total cost per hat, including the plastic and fabric, would be \$2.75 (\$2.75 = \$0.75 + (\$100/50)).

But if you cranked up production volume and produced 100 hats per month, then each hat would incur \$1 dollar of fixed costs, because fixed costs are spread out across units of output. The total cost per hat would then drop to \$1.75 (\$1.75 = \$0.75 + (\$100/100)). In this situation, increasing production volume causes marginal costs to go down.

RELATED TERMS
1. ### Unit Cost

Unit cost is the cost incurred by a company to produce, store ...
2. ### Fixed Cost

A fixed cost is an expense that remains the same regardless of ...
3. ### White Hat

A white hat is an ethical practice used to improve computer and ...
4. ### Marginal Social Cost - MSC

Marginal social cost (MSC) is the total cost to society as a ...
5. ### Top Hat Plan

A top hat plan is a non-qualified employer-sponsored plan designed ...
6. ### Cost Accounting

Cost accounting is an accounting method that aims to capture ...
Related Articles
1. Investing

### Red Hat Stock Jumps on Strong Earnings, Outlook

Talk about ending a year with a bang: Open-source software leader Red Hat (NYSE: RHT) absolutely nailed its fourth quarter and fiscal 2016, which it reported Monday after the close, and its ...
2. Investing

### Red Hat Guides High, Driven by Public Cloud

Shares of the software provider hit new highs on current-quarter and full-year 2018 guidance beats.

### How Gross Margin Can Make or Break Your Startup

Find out how your startup's gross margin can impact your business, including why a mediocre margin may spell disaster for a budding business.

Find out what margin is, how margin calls work, the advantages of leverage and why using margin can be risky.
5. Investing

### Key Financial Ratios for Manufacturing Companies

An investor can utilize these financial ratios to determine whether a manufacturing company is efficient, profitable and a good long-term investment option.

### Red Hat Stock Breaks Out After Bullish Q4 Results

Red Hat shares moved sharply higher following fourth quarter earnings, but technical indicators paint a more bearish picture.
RELATED FAQS
1. ### How is marginal revenue related to the marginal cost of production?

Learn about the marginal cost of production and marginal revenue and how the two measures are used together to determine ... Read Answer >>
2. ### What is the difference between fixed cost and total fixed cost?

Learn what a fixed cost is, what a variable cost is, what total fixed costs are, and the difference between a fixed cost ... Read Answer >>
3. ### What Is Operating Margin vs. Contribution Margin?

Understand the difference between two measures of profitability, operating margin and contribution margin, and the purpose ... Read Answer >>
4. ### Profit margin versus operating margin: What's the difference?

There are some distinctions between profit margin and operating margin. Both measure efficiency of a firm, but one takes ... Read Answer >>
5. ### How are direct costs and variable costs different?

Direct costs are expenses that can be directly traced to a product, while variable costs vary with the level of production ... Read Answer >>
6. ### Gross Margin vs Operating Margin: What the difference?

Understand the difference between gross margin and operating margin in relation to evaluating a company's overall profitability ... Read Answer >>