Marginal cost
Learn what marginal cost is, how to calculate it and how to use it to price orders and plan production.
Published Wednesday 30 September 2026
Table of contents
Key takeaways
- Marginal cost is the added cost of producing one more unit, and it comes from variable costs because fixed costs stay the same
- You calculate marginal cost by dividing the change in total cost by the change in quantity
- Each additional unit adds profit as long as its marginal cost stays below your selling price
- Stepped and semi-variable costs can distort the figure, so use marginal cost alongside average cost and cash flow planning
What is marginal cost?
Marginal cost is the extra cost of producing one more unit of a product or service. It measures the change in your total cost when output moves from one level to the next.
Say it costs you RM320 to make 100 candles and RM325 to make 101. The marginal cost of that 101st candle is RM5.
Marginal cost comes from your variable costs, which rise and fall with production. Many of these are direct costs, like the wax in a candle or the flour in a loaf. Fixed costs such as rent and insurance stay the same when you make one more unit, so they drop out of the calculation.
Two other cost measures help put marginal cost in context.
- Total cost is everything you spend to produce all your units, with fixed and variable costs combined
- Average cost is total cost divided by the number of units, which blends fixed and variable costs into one figure
Marginal cost looks only at the next unit. That makes it the figure to use when you’re deciding whether to make more or less.
Why marginal cost matters for your business
Your marginal cost gives you a clear number to base everyday decisions on. Knowing it helps you:
- set prices that protect your margin, since an RM12 marginal cost and an RM20 price means each additional sale adds RM8
- weigh bulk discounts and wholesale deals before you agree to them
- build realistic budgets and more reliable cash flow projections for your next production target
- find the output level where each extra unit starts to get expensive
- catch rising costs early by tracking the figure month by month, so you can fix the cause before it eats into your margin
Marginal cost formula
The marginal cost formula divides the change in total cost by the change in quantity. Here’s the formula on its own:
Marginal cost = change in total cost ÷ change in quantity
Each part of the formula has a simple meaning.
- Change in total cost is your total cost at the new output level minus your total cost at the original level
- Change in quantity is the number of additional units you produce, whether that’s one unit or a batch of 100
Because fixed costs stay the same, the change in total cost comes from variable costs such as materials and direct labour. For a single additional unit, marginal cost (MC) has a shorter form based on total cost (TC):
MC = TC(n) − TC(n − 1)
TC(n) is the total cost of producing n units, and TC(n − 1) is the total cost of one unit fewer. On a graph, marginal cost is the slope of the total cost curve: the steeper the curve, the more each extra unit costs.
How to calculate marginal cost in 3 steps
You can work out marginal cost in three steps using figures from your own records. This example compares two production levels.
- Find the change in total cost. If 200 units cost RM2,000 and 250 units cost RM2,400, the change is RM400.
- Find the change in quantity. Moving from 200 to 250 units gives you 50 additional units.
- Divide the cost change by the quantity change. RM400 divided by 50 gives a marginal cost of RM8 per unit.
If you sell each unit for RM15, every additional unit adds RM7 towards your fixed costs and profit.
Marginal cost example
A worked example shows how the numbers play out for a small bakery. Say you run a bakery making sourdough loaves.
Last month you baked 300 loaves for a total cost of RM1,800. That’s RM900 in fixed costs, such as rent and equipment leases, and RM900 in variable costs, such as flour and packaging.
Then a local café asks for an extra 50 loaves a month. At 350 loaves, your total cost rises to RM1,980. Fixed costs stay at RM900, while variable costs rise to RM1,080.
The numbers work out like this:
- total cost rises by RM180 (RM1,980 minus RM1,800)
- output rises by 50 loaves (350 minus 300)
- marginal cost is RM3.60 per loaf (RM180 ÷ 50)
- profit on each additional loaf is RM2.40 if the café pays RM6.00 (RM6.00 minus RM3.60)
Across 50 loaves, that’s RM120 in extra profit each month from saying yes to the café. For more scenarios like this one, try this marginal cost walkthrough.
Your marginal cost of RM3.60 is also well below your new average cost of RM5.66 per loaf (RM1,980 ÷ 350, rounded). That gap exists because your fixed costs are now spread across more loaves.
The marginal cost curve
Plot marginal cost against output and you’ll usually see a U-shaped curve. Knowing where you sit on it helps you plan for cost changes before they reach your bank account.
On the left side, marginal cost falls as output grows. You buy materials in bulk, and your team gets quicker with practice.
The bottom of the U is your most efficient output level, where each extra unit costs the least. For many small businesses, this lines up with the capacity of your current equipment and team.
On the right side, marginal cost climbs again because of diminishing returns. Staff work overtime and suppliers may add rush fees.
In economics, this rising section shapes supply: a business will only produce more when the price covers the higher cost of each extra unit. If your per-unit costs keep climbing, adding capacity may suit you better than pushing your current setup harder.
Marginal cost vs marginal revenue
Marginal revenue is the extra revenue you earn from selling one more unit. Comparing it with marginal cost shows you the most profitable level of output.
If you sell at a set price, your marginal revenue equals that price. Charge RM20 per unit and each additional sale brings in RM20.
Profit is highest where marginal cost equals marginal revenue. On either side of that point, the comparison tells you what to do next:
- when marginal cost is below marginal revenue, each additional unit adds profit, so keep producing
- when marginal cost is above marginal revenue, each additional unit reduces profit, so scale back or raise your price
The same test works for a large order at a discount: if the discounted price still beats your marginal cost, the order adds profit. For more ways to lift your margin, explore these profit-boosting ideas.
Marginal cost vs average cost
Average cost and marginal cost both measure production costs, and each answers a different question. Average cost is total cost divided by the number of units, while marginal cost looks only at the next unit.
The two follow a predictable pattern:
- when marginal cost is below average cost, each new unit pulls the average down
- when marginal cost is above average cost, each new unit pushes the average up
Average cost is at its lowest where the two are equal. In the bakery example, the RM3.60 loaves pulled average cost down from RM6.00 (RM1,800 ÷ 300) to RM5.66.
Use average cost to set your price floor, since your prices need to cover all your costs over time. Use marginal cost to decide whether one more order or batch is worth taking on.
Marginal cost pricing
Marginal cost pricing means setting a price at or just above the marginal cost of a product. It suits one-off orders when you have spare capacity and your regular sales already cover your fixed costs.
In the bakery example, any café price above RM3.60 a loaf adds to your profit. Your regular prices still need to cover your fixed costs, so keep marginal cost pricing for extra orders on top of your usual sales.
Some products have a marginal cost close to zero. One more software licence or digital download costs you almost nothing. Its price reflects the value to customers and the cost of building it.
Comparing pricing strategy options helps you choose the right approach for each product.
Marginal costing vs absorption costing
Marginal costing and absorption costing are two ways to value your inventory and report profit. The difference is how each method handles fixed costs. Here’s how they compare:
- marginal costing values each unit at its variable cost and charges fixed overheads in full to the period they occur in
- absorption costing spreads a share of fixed production overheads across every unit, so each unit carries part of the fixed cost
Using last month’s bakery figures, variable cost is RM3 a loaf (RM900 ÷ 300). Marginal costing values each loaf at RM3, while absorption costing adds RM3 of fixed cost (RM900 ÷ 300) for a total of RM6.
The two methods give different profit figures when you finish a period with unsold stock. Marginal costing suits day-to-day decisions because it shows how costs move with output.
Marginal costs versus stepped costs
Marginal cost assumes your costs rise smoothly as you produce more. Some costs jump in steps instead, and these are called stepped costs.
A stepped cost stays flat across a range of output, then jumps when you pass a capacity limit. Take warehouse rent: you pay the same whether you store 100 or 900 boxes. Once you need room for 1,000, you rent a second unit and your storage cost doubles.
Other common stepped costs include:
- hiring another employee when your team reaches its full workload
- leasing a second machine when the first runs at full capacity
- renting a larger workspace when you need more room
- adding a delivery vehicle when orders exceed your current routes
Say each additional unit costs RM4 to make, but unit 501 triggers an RM2,000 equipment lease. Moving from 500 to 501 units then costs RM2,004, even though the lease supports many future units.
Map these thresholds alongside your marginal costs and add them to your cash flow forecast. You can then time each step for when demand is strong enough to cover the higher cost.
Limitations of marginal cost analysis
Marginal cost is a useful guide, and it works best alongside other checks. Keep these limits in mind when you use it:
- semi-variable costs, such as a phone plan with a monthly fee plus usage charges, are hard to split into fixed and variable parts
- stepped costs can make one additional unit far more expensive than the formula suggests
- the simple model assumes a constant selling price, while bulk discounts lower your marginal revenue
- the figure takes a short-term view, so pair it with a yearly check that your sales cover your fixed costs
Your margin of safety adds that longer view. It shows how far sales can fall before your business stops making a profit.
Track your costs and pricing decisions with Xero
Marginal cost is only as reliable as the cost data behind it. Xero pulls in your transactions through bank feeds and turns them into easy-to-read reports, so you can see how costs shift with every order.
Set up customisable reports to track variable costs over time, then price new orders with confidence. See how Xero works for your business when you get one month free.
FAQs on marginal cost
Here are quick answers to common questions about marginal cost.
Can marginal cost be calculated at zero output?
Yes, for the first unit: compare the total cost of making one unit with your total cost at zero output, which equals your fixed costs. The result is the variable cost of that first unit.
Can marginal cost be negative?
In theory, yes, if producing more unlocks a supplier discount big enough to lower your total cost. It’s rare in practice, so double-check your figures if you see it.
How does marginal cost apply to service businesses?
Services have marginal costs too, such as contractor hours or app subscriptions for each new client. If one more client needs RM150 of contractor time and an RM50 app add-on each month, your marginal cost is RM200 a month.
How often should you recalculate marginal cost?
Recalculate it whenever supplier prices or wages change. Reviewing it monthly alongside your profit and loss report helps you see trends while they’re still small.
Related terms
Learn more about marginal cost
Handy resources
Advisor directory
You can search for experts in our advisor directory
Xero Small Business Guides
Discover resources to help you do better business
Try Xero for free
Try Xero’s fast, simple, powerful online accounting software for your small business
Disclaimer
This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.