Marginal cost

Published Thursday 23 July 2026

Table of contents

• What is marginal cost?
• Why marginal cost matters
• The marginal cost formula
• Marginal cost vs average cost
• Marginal cost and economies of scale
• Marginal cost vs marginal revenue
• Marginal costs versus stepped costs
• Manage your production costs with Xero
• FAQs on marginal cost
• Related terms
• Learn more about marginal cost

Key takeaways

• Marginal cost is the cost of producing one more unit of a product or service.
• You work it out by dividing the change in total cost by the change in quantity produced.
• A low marginal cost gives you room to make more, price more competitively, or protect your profit on each sale.
• Marginal cost tends to fall as you use spare capacity, then rise once you have to invest in more space, equipment, or staff.

What is marginal cost?

Marginal cost is the extra cost you take on to produce one more unit of whatever you sell. It's also called the marginal cost of production or the incremental cost.

It only counts the costs that change when output changes, such as materials and direct labour. Fixed costs like rent stay out of it, because they don't move when you make one more item.

Why marginal cost matters

Marginal cost tells you what the next unit really costs you, which is often less than you'd expect. Once your tools, premises, and systems are already paid for, making one more item can be surprisingly cheap.

That gap matters for your bottom line. When your marginal cost is low, you can afford to increase production, sell each extra unit at a healthier profit, or offer better prices to win more customers.

The marginal cost formula

The marginal cost formula is straightforward, and it uses figures you can pull from your own records. You divide the change in total cost by the change in quantity produced:

Marginal cost = change in total cost / change in quantity

Say it costs you $5,000 to produce 100 units, and $5,030 to produce 101 units. Your total cost went up by $30 to make that one extra unit, so your marginal cost is $30 divided by 1, which is $30.

If you want a step-by-step walkthrough with more examples, see this guide on how to calculate marginal cost.

Marginal cost vs average cost

Marginal cost and average cost sound similar, but they answer different questions. Average cost spreads your total cost across every unit, while marginal cost looks only at the next one.

Using the same figures, 100 units at a total cost of $5,000 gives you an average cost of $50 per unit. The 101st unit only costs $30 to make, so that extra unit costs less than your average and pulls your average cost down.

Marginal cost and economies of scale

Marginal cost rarely stays flat as you grow, and plotting it usually gives you a U-shaped curve. It tends to fall first, then climb once you start pushing against your limits.

Early on, each extra unit spreads your setup and equipment across more output, so marginal cost drops. That's economies of scale at work. Once you near full capacity, you pay for overtime, rushed materials, or wear on your equipment, and marginal cost starts to rise again.

Marginal cost vs marginal revenue

Marginal revenue is the extra money you earn from selling one more unit. Comparing it with marginal cost shows you exactly how far it pays to keep producing.

Your profit is highest at the point where marginal cost equals marginal revenue. Produce beyond that point and each extra unit costs more to make than it brings in, so you lose money on every additional sale.

Marginal costs versus stepped costs

Marginal costs assume you can add one more unit within your current setup. Stepped costs are what you face when that setup runs out of room.

Once you hit capacity, making more means a bigger investment, such as a new workshop, extra equipment, or more staff. These stepped costs jump all at once and take a lot more sales to pay back, so it's worth knowing your break-even point before you commit.

Manage your production costs with Xero

Keeping an eye on your costs is easier when your numbers live in one place and update as you go. Xero brings your income and expenses together so you can track what each product really costs and see how changes affect your profit margin, and you can get one month free.

FAQs on marginal cost

Here are answers to some frequently asked questions about marginal cost.

How do you calculate marginal cost?

Divide the change in your total cost by the change in the quantity you produce. If making one more unit adds $30 to your total cost, your marginal cost is $30.

What is the difference between marginal cost and marginal revenue?

Marginal cost is what one more unit costs you to produce, while marginal revenue is what that same unit earns you. Your profit peaks where the two are equal.

What is the difference between marginal cost and average cost?

Average cost divides your total cost across all units, while marginal cost looks only at the next unit. The next unit can cost more or less than your average.

What is marginal cost pricing?

Marginal cost pricing means setting your price close to what it costs to make one more unit. It can help you win extra sales when you have spare capacity, as long as your fixed costs are already covered.

Related terms

• Direct costs
• Cost of sales
• Cost of goods sold
• Break-even point
• Profitability

Learn more about marginal cost

• Marginal cost calculation
• Profit margin
• Pricing strategies and COGS
• How to measure profitability