Incremental Costs Marginal Costs Marginal Costs, Exercises for Economics

Incremental Costs Marginal Costs Marginal Costs, Exercises for Economics

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Incremental Costs Incremental costs are associated with a choice and therefore only ever include forward-looking costs. Previously made purchases or investments, such as the cost to build a factory, are called “sunk” costs and are not included. The Incremental cost can include many different direct and indirect cost inputs depending upon the situation. However, only costs that will change as a result of the decision are to be included. When a factory production line is at full capacity, the incremental cost of adding another production line might include cost of the equipment, the people to staff the line, electricity to run the line and additional human resources and benefits.

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.

Marginal Costs Marginal cost is a more specific term, referring to the cost to produce one more unit of product or service. Originally used to optimize production, products with high marginal costs tend to be unique, labor intensive or at the beginning of a product life cycle. Low marginal cost items are often very price competitive. The classic example is the cost to print encyclopedias. It costs a lot to print the first encyclopedia. Research must be done, entries written, copy typeset. But it requires very little additional cost to print the 10,000th encyclopedia. Marginal cost may equal incremental cost when only one additional unit is being considered.

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.

A typical marginal cost curve with marginal revenue overlaid. Price is on the vertical axis and quantity on the horizontal axis.

In economics, marginal cost is the change in the opportunity cost that arises when the quantity produced is incremented by one unit, that is, it is the cost of producing one more unit of a good. [1] Intuitively, marginal cost at each level of production includes the cost of any additional inputs required to produce the next unit. At each level of production and time period being

considered, marginal costs include all costs that vary with the level of production, whereas other costs that do not vary with production are considered fixed. For example, the marginal cost of producing an automobile will generally include the costs of labor and parts needed for the additional automobile and not the fixed costs of the factory that have already been incurred. In practice, marginal analysis is segregated into short and long-run cases, so that, over the long run, all costs (including fixed costs) become marginal.

If the cost function {\displaystyle C} C is differentiable, the marginal cost {\displaystyle MC} MC is the first derivative of the cost function with respect to the quantity {\displaystyle Q} Q.[2]

{\displaystyle MC(Q)={\frac {\ dC}{\ dQ}}} {\displaystyle MC(Q)={\frac {\ dC}{\ dQ}}}

The marginal cost can be a function of quantity if the cost function is non-linear. If the cost function is not differentiable, the marginal cost can be expressed as follows.

{\displaystyle MC={\frac {\Delta C}{\Delta Q}}} MC = \frac{\Delta C}{\Delta Q}

where {\displaystyle \Delta } \Delta denotes an incremental change of one unit.


Assignment No: 2

Topic: Incremental and Marginal Cost


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