Marginal cost (calculation)
Marginal cost tells you the incremental cost of making more products or delivering more services. It is the change in costs divided by the change in production.
Working out marginal costs allows a business to understand the financial risks and opportunities of increasing production.
Marginal cost formula.
Marginal cost example
A business makes 100 wallets for $1000. To produce 101 wallets, they only have to spend another $5 on extra materials.
While the average cost of producing wallets was $10, the marginal cost of an extra wallet is just $5.
Example of marginal revenue
Our wallet maker usually retails their product for $30 each at a market stall. However, they decide to supply the surplus wallet at a wholesale rate of $20, to a stall holder on the other side of town.
While each sale previously generated $30 in revenue, the extra wallets are sold for less and contribute $20 in revenue.
Example of marginal profit
Our wallet maker has traditionally made $20 profit on every sale. The extra wallet will generate $15 in profit. Due to the lower cost, however, the profit margin will actually be higher (75% vs 67%).
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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.