Understanding Marginal Cost in Business Decision-Making


Added on  2019-09-26

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MARGINAL COST1st August 2019 Inresearch,production,retail, accounting and other operating activities of an organisation,acoststands as the value of money which has been incurred for producing something ordelivering a service. Hence, cost is a one-time element to be used and once it used for the firsttime, it becomes unavailable to use anymore. Inbusinesses, cost comes as an element used foracquiring something i.e. a particular amount of liquid cash spend for acquiring an asset orsomething else is treated as a cost. In this particular case, money acts as the input which is gonein the process of acquiring a tangible thing, sometimes intangible too. This type of acquisitioncost refers as the sum of production cost which is incurred by a product’s original producer.Though a sum of money is incurred while acquiring an asset (income-generating asset), it is nottreated as cost whereas it is treated as an expense. In more generalised term and considering theeconomics, cost refers to ametricwhich is totaling-up as a result of a particular process. A particular amount that must be given up or paid for getting something tangible or intangible iscalled cost. In business operation, cost stands as a valuation, monetary in form, of effort,material, resources, utilities and time consumed, cash and risks incurred, as well as theopportunity gave up in the practice of production of products or services and its delivery. Allkinds of expenses are treated as costs, but not all types of costs are considered as expenses. Costor costs are often described on the basis of their applicability and timing. In accounting as well asin economics, there are a number of costs such as accounting cost,historical cost,opportunitycost,marginal cost,transaction cost, and sunk cost. All these costs are considered by businesseswhile computing cost of products, pricing of final products, profit from business and more.Moreover, these are also taken into account by a company’s management personnel while theytend to make business related decisions.Meaning of Marginal Cost with ExampleMarginal cost refers to the change in the total cost which comes from producing or making onemore additional item. It is an additional cost a producer or manufacturer incurs for producing an
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additional unit of output. The marginal cost of production is analyses with the purpose ofdetermining the exact point at which a company can achieveeconomies of scale. Morespecifically, the decrease or increase in a company’s total cost of production to make only onemore i.e. an additional unit of a product is the marginal cost. Marginal cost is computed by acompany when it becomes able to reach break-even point where the total fixed costs is beenabsorbed by the items that are already produced and the direct or variable costs left for beingaccounted.The calculation of marginal cost is done by applying the following formula –Marginal Cost = Change in total cost / the change in outputMarginal costs elements are variable in nature, which consist of material costs, labour cost alongwith an estimated part of a company’s fixed costs related to its products such as selling expensesand administration overheads. In those companies, where average costs remain fairly constanti.e. almost fixed, marginal cost becomes equal to the average cost. Moreover, in heavy industriessuch as in automobile plants, mines, and airlines which require a large amount of capitalinvestment and have huge average costs, marginal cost remains very low compared to otherindustries which are not involved or require large capital investments. The calculation of themarginal cost of production is mostly used by manufacturers in order to isolate an optimum levelof production.It is often found, that manufacturersexamine the costs of adding an additional unitto their existing production schedules. The reason behind this is, at some points of time, thebenefit attached to the production of one extra unit of product or service and generating incomefrom that extra item brings the total cost of production of theproduct-linedown. In production, marginal cost includes all kinds of costs which use to vary according to the levelor unit of production. For instance, when a company tends to establish a new production unit orfactory with the aim of producing more products, the cost incurred by the company forestablishing the new factory is treated as marginal cost. Furthermore, the amount in relation tomarginal cost uses to vary in accordance with the production volume that is being produced.There are a number of economic factors responsible for creating an impact on the marginal cost.These economic factors include information asymmetries, negative and positive externalities,
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