Incremental Cost Vs. Marginal Cost

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Every business has costs. These include the fixed costs, such as the electric bill, and variable costs, such as the cost of raw materials. Other costs are harder to define, such as the cost of expansion or the cost of warehousing extra products. Economists study these "hazy" costs in detail, and report on how the closely related incremental costs and marginal costs affect a business.

Understanding Incremental Cost

  • According to "The Free Dictionary," incremental cost is the cost of adding or subtracting one extra unit of product or output. For example, a restaurant is only allowed to seat 100 people, per the fire department regulations. The restaurant is doing well, and wants to seat 101 people or more. The owners will have to build an addition with extra fire escape doors. The restaurant will have to incur thousands of dollars of building costs for the addition, just to seat one extra person.

Understanding Marginal Cost

  • A marginal cost is slightly different from an incremental cost. According to the National Productivity Council of India, or NPCI, marginal cost is the original cost plus the extra cost of producing an extra unit of output, resulting in a total cost. In the restaurant example, the original pre-existing building costs are added in to the new cost of building the addition, resulting in a total cost.

Inter-Relationship of Costs

  • Both incremental and marginal costs are strongly interrelated -- they are almost the same. The overall understanding is that the total cost is affected by increasing or decreasing the output. Every time a company changes its output, both marginal and incremental costs parallel each other accordingly.

Differences of Costs

  • The NPCI notes that a small difference does exist between the two costs. This difference is more philosophical in nature than in "hard numbers." Marginal costs deal with adding or subtracting output. Incremental costs are based on the decision to add or subtract output. In the restaurant example, the owners calculate the cost of building the addition. The question, however, is to whether build the addition or not.

References

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