What Is the Meaning of Marginal Cost?
The marginal cost is the additional cost required to produce the last unit of something. If the cost for producing 100 widgets is $1,000 and the cost of producing 101 widgets is $1020, the marginal cost of producing the 101st widget is $20. The marginal cost should not be confused with the average cost. Where the marginal cost in the example is $20, the average cost per widgets is $10. While the total costs of production always increase as production increases, the marginal cost of a product may not.
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Production
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If the marginal revenue (profit) is greater than the marginal cost, a company increases productivity; however, once the marginal revenue is less than the marginal cost, a company adjusts the level of production in order to produce the profit-making quantity or when marginal costs is equal to marginal revenue.
Calculating Marginal Cost
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The marginal cost (MC) equals the change in cost (C) divided by the change in unit production (U). If the cost to produce 5,000 widgets is $2,500 and the cost is $9,500 for 10,000 widgets, then the change in cost (C) would be $7,000 and the change in units produced (U) is 5,000. The equation would look like this:
C ÷ U = MC
$7,000 ÷ 5,000 = $14Therefore, the marginal cost (MC) for widget production is $14.
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Social and Private Cost
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The marginal social cost (MSC) is the total cost to society in producing one extra unit, which includes the direct costs and costs to the external environment. The marginal private cost (MPC) is the additional cost incurred by a company for the production or use of a single additional unit (product). Businesses use MPC to establish the company's profit-maximizing goal as well as the power of individuals for purchasing and consumption choices.
Negative Externalities
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A negative externality is when the cost to society of making a product is greater than the cost to the consumer who is paying for it. In an unregulated market, producers who do not accept responsibility for external costs pass this responsibility onto society. While the company is responsible for production and material costs, individuals are responsible for the consequences of increased production. For example, a factory pollutes the air producing their product. However, the individuals living near the factory pay for the pollution through higher medical expenses, reduced aesthetic appeal and a lower quality of life. Thus the production of the product has a negative cost to the people surrounding the factory---a cost not paid for by the firm.
Positive Externalities
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When the marginal social cost (MSC) of production is less than the private cost, a positive externality occurs, i.e., the benefits to the company are less than the benefits to society. In an unregulated market where a positive externality exists, consumers pay less and consume less. Examples of a positive externality include immunizations, which prevents the spread of disease; yard maintenance, which improves home value; and beekeepers collecting honey for sale, with the bees pollinating fields and thus helping farmers.
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