How To Find Marginal Cost? Why Is It Important For Businesses?
May 31, 2023
If you are an entrepreneur, you must know how important it is to balance the costs of production and its selling price. If you see that production costs are higher than the revenue earned from sales, then you must optimize your production process. To understand this better, you must know what marginal cost is and how to find marginal cost.
Therefore, if you wish to make your business more optimized and earn better revenue and profits, read this post till the end to learn about marginal costs.
What Is Marginal Cost?
For businesses, the marginal costs refer to the additional expenses induced for producing an additional unit of a product.
The primary purpose of learning how to find marginal cost is to determine the worthiness of increasing production. This is important because every business needs to make profits. If the overall manufacturing costs increase to become more than its selling cost, then it’s not a good idea to increase production. Therefore, you must also understand gross sales vs net sales.
What Is The Difference Between Marginal Cost And Average Cost?
Since marginal cost calculates the additional costs of producing an extra unit of the product, shouldn’t it be the same as the average cost of production?
The answer is no, they are not the same. This is because the average cost of production remains the same – the same as the cost of producing one unit.
On the other hand, the marginal cost of production declines over time. This is because all businesses grow over time. Therefore, when they become economies of scale, their production processes will also get better optimized. This will have a significant impact on marginal cost.
Therefore, learning how to calculate net sales and how to calculate gross profit are also essential in understanding the functioning of marginal cost.
How To Determine Marginal Cost?
If you wish to learn how to find marginal cost, then you must also learn how to use the marginal cost calculator. Calculating marginal cost is not that difficult once you learn this formula and are able to apply it effectively.
Similar to learning how to find marginal revenue, the marginal cost formula is exactly as explained below:
| Marginal Cost = Change In Total Expenses / Change In Quantity Of Units Produced. |
Here, change in total expenses refers to the costs of producing one additional unit of the product. It is calculated by simply adding the cost of producing one additional unit to the overall costs of producing all of them.
On the other hand, a change in the number of units produced refers to the number of additional units produced. When it comes to calculating its marginal cost, it’s typically considered as 1 if only one additional unit is produced. Therefore, it’s the change in total expenses that contribute the most towards learning how to find minimum marginal cost.
Here’s an example for you:
| Suppose your business produces 24 smartphones for $500 dollars each per month. Therefore, your total production cost will be 24 x $500 = $12,000. However, you have decided to produce 25 smartphones per month from now on. Therefore, your overall production cost should become 25 x $500 = $12,500. Now, if you apply the marginal costs formula, then your marginal costs would be $500. |
This is the most basic way of learning how to find marginal cost. However, do note that marginal costs don’t necessarily refer to the additional costs of producing one additional unit. It refers to the overall costs of manufacturing additional units.
Here’s another example for you, based on the example above:
| Suppose your business produces 24 smartphones for $500 dollars each per month. Therefore, your total production cost will be 24 x $500 = $12,000. However, you have decided to produce 50 smartphones per month from now on. Therefore, your overall production cost should become 50 x $500 = $25,000. Now, if you apply the marginal cost formula, then your marginal costs will be $25,000 – $12,000 = $13,000. |
Understanding Marginal Cost – Why Is It Important?
Understanding how to find marginal cost of your business is crucial for every entrepreneur and finance manager. This is because finding the marginal cost of your business operations allows you to optimize your production better. Understanding marginal costs is more important for manufacturing businesses than service-based businesses.
The primary benefits of calculating marginal cost similar to how to calculate revenue are:
1. Better Cost Vs Benefit Analysis
As you already know, marginal cost is the additional cost of producing one additional unit of a product. On the other hand, the marginal benefit refers to the additional benefit a customer will get if they purchase one additional unit of the product.
Here, you need to understand the marginal cost of producing one additional unit of a product remains the same. However, the marginal benefit of purchasing one additional product will keep on diminishing for consumers.
Therefore, you must question yourself – is it worth it to produce one additional unit of a product? Will the marginal cost of producing one additional unit of the product be worth it for consumers? Is the cost of employing one more employee worth it to increase production and value for consumers?
Understanding the impact of marginal costs on the overall value generated for consumers plays a great role. Since optimizing production costs is essential, you have to weigh the marginal benefit it will provide.
2. Make Better Business Decisions
Understanding marginal costs will allow you to determine whether the marginal revenue is worth it or not. If the marginal cost of producing an additional unit is higher than the marginal revenue generated from it, maybe it’s not wise to do so.
It’s such production-related business decision-making that gets easier if you fully understand what the marginal cost is. Plus, aligning it with marginal benefits for customers and their probability of buying an additional product is essential for you.
Therefore, as an entrepreneur, understanding the importance of understanding marginal costs for better decision-making is crucial.
Bottom Line: Is It Worth It To Produce Extra?
As an entrepreneur or a finance manager, learning how to find marginal cost is essential for making better business decisions. Understanding marginal costs also helps you optimize your production processes so that you can make higher profits.
If you have any queries regarding marginal costs, comment below and I will sort your problems out!
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