Marginal Cost Formula (Table of Contents)
- Marginal Cost Formula
- Marginal Cost Formula Calculator
- Marginal Cost Formula in Excel (With Excel Template)
Marginal cost formula
Marginal cost formula is nothing but the mathematical representation to capture the incremental cost impact due to a production of additional units of a good or service. It is computed by dividing the change in total cost due to the production of additional goods by the change in the number of goods produced. Although the total cost is comprised of fixed cost and variable costs, the variation in total cost due to a change in the quantity of production is primarily because of variable cost which includes labor and material cost. On the other hand, there might be few occasions when there is increase witnessed in fixed costs which include administration, overhead and selling expenses. Mathematically,
The marginal cost formula can be useful in financial modeling to arrive at the optimum level of production required to ensure a positive impact on the generation of cash flow.
Examples of Marginal cost formula
Marginal Cost Formula Example No 1:
Let us consider a simple example where the total cost of production of a company stood at $5,000 for the production of 1,000 units. Now, let us assume when the quantity of production is increased from 1,000 units to 1,500 units, the total cost of production increased from $5,000 to $6,000.
- Marginal cost = ($6,000 – $5,000) / (1,500 – 1,000)
- Marginal cost = $1,000 / 500
- Marginal cost = $2 which means the marginal cost of increasing the output by one unit is $2
Marginal Cost Formula Example No 2:
A public limited automobile company manufactured 348,748 units of vehicles (includes M&HCV, LCV, Utility, and Cars) during FY2017, incurring total production cost of $36.67 billion. The following year in FY2018, driven by positive market demand the production increased substantially requiring the purchase of more raw materials as well as hire more manpower. Such spurt in demand resulted in overall production cost to increase to $39.53 billion to produce a total of 398,650 units in that year.
- Marginal cost = ($39.53 billion – $36.67 billion) / (398,650 –348,748)
- Marginal cost = $2.86 billion / 49,902
- Marginal cost = $57,312 which means the marginal cost of increasing the output by one unit is $57,312
Explanation of Marginal Cost Formula
Marginal cost formula can be determined by the following three simple steps:
- Compute the change in total cost
- Compute the change in the quantity of production
- Divide the change in total cost by the change in quantity produced
Change in total cost
At each level of production, the total cost of production may witness surge or decline, based on the fact whether there is a need to increase production volume or decrease the same. If the production of additional units warrants an increase in the purchase cost of raw material and requires hiring an additional workforce, then the overall production cost is expected to change. To compute the change in total production cost, just deduct the initial production cost incurred during the first batch from the production cost incurred during the next batch when the output has been increased.
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Change in quantity produced
From a manufacturing unit’s point of view, it is quintessential to track the quantities involved at each production level. A rise or decline in the output volume production eventually is reflected in the overall cost of production and as such it is important to know the change. To compute the change in the quantity of production, the quantity of units produced in the initial production run is deducted from the quantity of units produced in the next production run.
Significance and Use of Marginal Cost Formula
In a perfectly competitive market, a company arrives at the volume of output to be produced based on marginal costs and selling price. Whenever a company performs financial analysis to arrive at product pricing and check production feasibility, marginal cost analysis forms an important part of the overall analysis based on which the management can assess the price of each good or service being offered to consumers. Now let us consider the following two scenarios to understand the relevance of the marginal cost formula.
Scenario 1: Let us assume that the selling price for a product is greater than the marginal cost of production, then in this scenario, the additional production will generate incremental cash flow which is a valid reason to increase the production.
Scenario 2: Let us assume that the selling price for a product is less than the marginal cost of production, which means that the company will be incurring losses and therefore either the additional production should not be continued or the selling price should be increased. As such, marginal cost formula forms an important part of business decisions pertaining to continuation of production operations.
Marginal Cost Formula Calculator
You can use the following Marginal Cost Formula Calculator
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Marginal cost formula in Excel (With excel template)
The following table gives a snapshot of how marginal cost varies with the change in quantity produced. Further, the graph for marginal cost reverses trend after a certain when which indicates that after a certain level of production the cost of production starts to increase after an initial phase of moderation. At this stage, one needs to check if the cost of production is less than selling price and if that is the case then stop the incremental production.
Here we will do the same example of the marginal cost Formula in Excel. It is very easy and simple. You need to provide the two inputs i.a change in total cost and change in Quantity
You can easily calculate the marginal cost Formula in the template provided.
First, we have find out change in total cost:
Then, we have find out a change in Quantity:
After that we get Marginal cost by using marginal cost formula:
This has been a guide to Marginal Cost Formula, here we discuss its uses along with practical examples. We also provide you with Marginal Cost calculator along with downloadable excel template.