Marginal cost
Learn what marginal cost is, how to calculate it, and how to use it for pricing and production.
Published Monday 31 August 2026
Table of contents
Key takeaways
- Marginal cost is the cost of producing one more unit of your product or service
- You calculate it by dividing the change in total cost by the change in the number of units
- Marginal cost usually comes from variable costs, so it falls as you produce more, then rises once you stretch past your capacity
- Comparing marginal cost with your selling price helps you set prices, plan production, and decide whether a bigger order is worth taking
What is marginal cost?
Marginal cost is the extra cost you take on to produce one more unit of a product or service. It answers a simple question: if you make one additional item, how much more will it cost you?
Most of that extra cost comes from variable costs like materials, packaging, and hourly labour. Fixed costs such as rent stay the same whether you make 10 units or 100, so they rarely change your marginal cost.
Picture a small bakery in Manila. The oven, the shop lease, and the monthly bills cost the same each month. Baking one more tray of pandesal only adds the flour, yeast, and power for that batch, and that added amount is your marginal cost.
Why marginal cost matters
Marginal cost gives you a clear view of what growth really costs. When you know the cost of the next unit, you can price it, plan for it, and decide whether making more is worth your while.
It turns a gut-feel decision into a number you can check. That matters most when a large order lands or demand shifts and you need an answer quickly.
How to calculate marginal cost
You can work out marginal cost from figures already in your accounts. According to the Corporate Finance Institute, marginal cost is the total change in the cost of producing more goods divided by the change in the number of goods produced. Follow these three steps.
1. Note your total cost now
Record your total cost at your current level of output. Pull the figure from your accounts or your cost of sales, so it reflects what you actually spend.
2. Note your total cost after you produce more
Work out your total cost once output rises to the new level. Include any extra spending on materials, labour, or supplies for those units.
3. Divide the change in cost by the change in units
Subtract the two totals to find the change in cost, then divide by the number of extra units. The result is your marginal cost per unit. Keeping tidy bookkeeping records makes each figure quicker to find.
Marginal cost example
A worked example shows how the formula behaves in practice. Say a furniture maker in Cebu builds 20 chairs a month for a total cost of ₱40,000. To fill a bigger order, output rises to 25 chairs and total cost rises to ₱46,000.
The change in total cost is ₱6,000, and the change in quantity is five chairs. Divide ₱6,000 by five and the marginal cost is ₱1,200 per chair. If each chair sells for more than ₱1,200, the extra output adds to profit.
Fixed costs versus variable costs
Marginal cost depends on how your costs behave when output changes. Splitting your spending into two groups makes the calculation clearer.
- Variable costs rise and fall with output, such as raw materials, packaging, and hourly wages
- Fixed costs stay the same across a range of output, such as rent, insurance, and salaried staff
Because fixed costs hold steady, marginal cost is driven mainly by your variable costs. Many of those variable costs also sit inside your cost of sales.
The marginal cost curve and diminishing returns
Plot marginal cost against output and it often forms a U-shape. Marginal cost tends to fall at first, then climb once you produce beyond a comfortable level.
The dip comes from spreading setup and bulk-buying savings over more units. The rise reflects the law of diminishing marginal returns: as you push past your usual capacity, extra output needs overtime, rush deliveries, or added equipment, so each unit costs more.
How businesses use marginal cost
Marginal cost turns up in day-to-day decisions about pricing and production. Here are the choices it supports.
- Set a price that covers the cost of each extra unit and still leaves a profit
- Decide how many units to make before your cost per unit starts to climb
- Judge whether a bulk order at a lower price is worth taking
- Spot the point where making more stops paying off
Economists describe the sweet spot as the level where marginal cost equals marginal revenue, the income from one more sale. Below that point, extra output adds profit; above it, each unit eats into your margin. Steady small business accounting keeps the numbers behind these calls up to date.
Marginal costs versus stepped costs
Marginal cost usually changes smoothly, one unit at a time. Some costs behave differently and jump in steps as you grow.
Say one delivery van covers your orders up to a point. Cross that point and you need a second van, so your cost leaps rather than creeps. That jump is a stepped cost, and it can push your marginal cost up sharply for the units that trigger the next step.
Short-run, long-run and near-zero marginal cost
In the short run, some costs are fixed, so marginal cost reflects mainly your variable spending. In the long run, you can change everything, including premises and equipment, so more costs come into play.
For some businesses, marginal cost is close to zero. A software maker or online course seller spends almost nothing to deliver one more copy, which is why digital products can scale so cheaply.
Track your production costs with Xero
Marginal cost is easier to act on when your sales and costs sit in one place. Xero brings your invoices, bills, and reports together, so you can watch your margins and price each product with confidence. To put accurate numbers behind every decision, get one month free and set up your business on Xero.
FAQs on marginal cost
Here are quick answers to common questions about marginal cost.
How do you calculate marginal cost?
Divide the change in your total cost by the change in the number of units produced. The result is the cost of making one more unit.
What is the difference between marginal cost and average cost?
Average cost spreads your total cost across every unit you make. Marginal cost looks only at the cost of the next unit, so it can sit above or below your average.
Is marginal cost the same as variable cost?
No. Variable cost is the total cost that changes with output, while marginal cost is the cost of one additional unit worked out from that change.
Why does the marginal cost curve slope upward at higher output?
Once you produce beyond your usual capacity, extra units need overtime, rush orders, or added equipment. Those added costs lift the marginal cost of each further unit.
Can marginal cost be zero?
It can come close for digital products like software or e-books, where one more copy costs almost nothing. For physical goods, materials and labour keep marginal cost above zero.
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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.