marginal cost

Definition

Increase or decrease in the total cost of a production-run, from making one additional unit of an item. It is computed in situations where breakeven point has been reached: the fixed costs have already been absorbed by the already produced items and only the direct (variable) costs have to be accounted for. Marginal costs are variable costs comprising of labor and material costs, plus an estimated portion of fixed costs (such as administration overheads and selling expenses). In firms where average costs are fairly constant, marginal cost is usually equal to average cost. However, in industries that require heavy capital investment (automobile plants, airlines, mines) and have high average costs, it is comparatively very low. The concept of marginal cost is of critical importance in resource allocation because, for optimum results, the management must concentrate its resources where the excess of marginal revenue over the marginal cost is maximum. Also called choice cost, differential cost, or incremental cost.