# Understanding Marginal Cost: Components and How to Calculate

Definition of marginal – In business operations, there are five types of costs that accompany the production process, namely fixed costs or fixed costs , variable costs or variable costs, total costs or total costs, average costs or average costs , marginal costs or marginal costs . Each type of cost has a different meaning, function and way of calculating. Of these various costs, the marginal cost is one of the most important which is useful for maximizing profit.

The definition of marginal in the Big Indonesian Dictionary (KBBI) means related to boundaries or edges that are not very profitable. In economics, marginal or marginal cost is the change in total cost that arises when the quantity produced increases or the cost of producing an additional quantity.

In certain contexts, marginal costs can be interpreted as costs that arise in the production of one additional good or service. In order to understand more about the notion of marginal in economics, consider the following explanation.

## Definition of Marginal Cost

The definition of marginal cost is an important aspect that must be considered in the process of producing goods. Of course, the company must really know how much it costs to spend on a certain production cycle and it is very important to be able to plan prices and produce goods.

In addition, marginal costs are decreases or increases in the total costs paid due to additions or reductions in one unit of additional product.

Marginal cost can also be defined as a cost that describes the rate at which the total cost of a product changes. Another understanding is that the marginal cost is a prediction of economic costs that will change if the output changes.

Initially, marginal costs tend to fall. But then marginal costs will quickly rise because the marginal returns to variable factor inputs will begin to decrease, until the use of marginal factors becomes more expensive.

This is known as the law of diminishing marginal returns or also known as the law of diminishing marginal returns . When marginal costs increase, the price of goods and services produced by a company will also increase to maximize profit.

Then, what is the importance of marginal cost? The main purpose of marginal cost is to determine the point at which a company is able to achieve economies of scale which becomes the value of the benefits it gets when the product becomes more efficient. This is done to be able to maximize the operational system as a whole.

Marginal cost is a very important economic theory, because a company that maximizes its profit will produce up to the point when marginal cost equals the company’s marginal revenue.

Entrepreneurs and management need to calculate the marginal cost, especially before the production process starts to find out the target output needed to reach the company’s profit point.

A company that maximizes profit will compare the marginal revenue received from output sold using the marginal cost of producing it.

If marginal revenue equals marginal cost, the company will produce a quantity of output that maximizes profit.

If marginal revenue tends to be less than marginal cost, then profit can be increased by increasing production. However, if the marginal revenue tends to be greater than the marginal cost, then profits can be boosted continuously by reducing production.

Therefore, determining the marginal cost is very important as one of the materials for making decisions and planning a business. However, the decision to increase or decrease production in order to maximize profit must also be based on other considerations. Examples include market prices or price competition and consumer purchasing power.

## Components of Marginal Cost

A data related to the types of costs in production, for example, fixed costs and also variable costs will usually be needed by the company. Fixed costs will not change, as the company’s production increases. Meanwhile, variable costs will exist in the opposite situation.

Variable costs depend more on production output and the constant number of units that the company will produce. When production volume and output increase, variable costs will also increase.

Examples are the variable costs of sales commissions as well as direct human resource and material costs. Meanwhile, fixed costs are costs that are constant regardless of production expenditures and no output results. Examples include employee salaries, god fees, insurance and office supplies.

## Formula and Method of Calculating Marginal Cost

After understanding what is meant by marginal cost or marginal cost and its components, here’s how to calculate marginal cost.

Basically, the formula used to calculate marginal cost is as follows:

Marginal cost = change in cost or change in quantity.

The following is an explanation of the marginal cost formula:

### Fee Changes

Changes in costs are the decrease or increase in production costs at each production level and during a certain period of time, especially when there is a need to produce more or less.

If in the manufacture of these additional units, it is necessary to recruit one or even two workers and increase the cost of raw materials. Then it will be certain that there is a change in production costs as a whole.

To determine the cost of change, Sinaumeds can deduct the existing production costs during the first production process from the production costs in the next wave when there is an increase in production.

### Quantity Change

At various levels of production, it is common for the quantity of goods produced to increase or even decrease. To determine the change in quantity, Sinaumeds needs to calculate the number of items made in the first production process, then subtract the volume of output made for the next production process.

After knowing the information and formula for marginal costs, Sinaumeds needs to take at least three steps to calculate marginal costs or marginal costs. Here’s the explanation:

Step 1

Determine the change in the quantity of the product or service.
To be able to calculate the marginal cost, of course, Sinaumeds must be able to know all the costs needed to make one product or service item that can be produced by the company. This total cost consists of fixed costs and variable costs.

Fixed costs must be the same throughout the cost analysis. Therefore, the first step that must be taken to be able to calculate the marginal cost is to determine the point at which the cost will change.

Step 2

Calculate the change in costs.
After Sinaumeds knows what changes in production quantity are, the next step is to calculate changes in costs. These cost changes can be obtained from reducing the total cost of the old production with the cost of the new production.

The value of the overall production costs, can be obtained by adding up fixed costs with variable costs. Fixed costs are costs that have a value that does not change during the period that Sinaumeds evaluates. Fixed costs include space rent, equipment costs and so on.

For the variable costs themselves, in general they will increase along with the increase in production costs. These variable costs include raw material costs, equipment costs, employee salaries and so on. To get variable costs, Sinaumeds can get them from the interval of the amount of goods or services produced.

After Sinaumeds values ​​fixed production costs and variable costs, all of the production costs will be easy to obtain. In addition, the value of the variable cost of production will also be obtained.

After knowing the value of fixed production costs and variable costs, the total production costs will be obtained. The value of changes in production costs will also be obtained.

Step 3

How to calculate the marginal cost or marginal cost.
Marginal cost is the cost required by the company to be able to make one additional unit of product. So that means, calculating the marginal cost can be done in order to find out if there is an increase in the cost required for each additional item of production.

In order to find out the marginal cost, Sinaumeds can get it by dividing the change in production costs required by the change in the number of products.

Sinaumeds can also obtain it by using the formula MC = TC/ Q, where MC is the marginal cost, while TC is the change in cost and Q is the change in the quantity of product.

Marginal cost or marginal cost will be obtained by dividing the change in production costs required by the change in product quantity. In addition, Sinaumeds also calculates it using the formula MC = TC/ Q as previously explained.

Performing calculations on marginal costs will be very useful to determine whether the flow of production should be continuously changed or not changed. In general, when there is an increase in output volume, the company will be able to achieve higher economies of scale and reduce marginal costs later.

This economy of scale can be obtained from specializing in human resources and utilizing production machines that work even more efficiently. An increase in output volume can help producers to get discounts or very large discounts to buy raw materials or raw materials.

But in the end, at a certain point a diseconomies of scale will emerge, namely when costs will increase far greater than the increase in output.

This kind of problem, in general, will occur due to overlapping jobs. This means that there will be more workers who will operate the company’s production machines.

An increase in the number of employees will also make work unable to coordinate properly. Likewise, the price of raw materials and the price of raw materials will become more expensive, because local supplies have run out.

In general, a company will operate at maximum output if the marginal cost equals the total units at average cost. If Sinaumeds draws a graph, then the marginal cost will also form a curve that resembles the letter U.

## Example of Calculating Marginal Cost

In general, the marginal cost formula is the change in the total cost of production divided by the change in the amount of production.

Marginal cost = change in total cost of production or change in the amount of production.

For example, marginal cost is part of the cost of production. Marginal costs can be seen from the production process. In the production process, there are several resources that remain constant regardless of how many additional requests are received.

These resources include fixed costs, such as sales, administration and overhead, for example . Meanwhile, additional resources may be needed later to increase production speed. The goal is to be able to meet additional requests.

The costs used to purchase and maintain these resources are referred to as variable costs which change with changes in production volume. For example, the cost of raw materials and labor.

For example, an entrepreneur named Ana owns a pastry production business. Every day, Ana produces 20 cakes using two cake-making machines and three employees.

On the eve of Idul Fitri, Ana received an additional request for 50 cakes every day, so to speed up the production process, Ana finally added 3 new employees and bought 1 more cake machine. In addition, the kitchen used for production was expanded by Ana.

In this example, the additional amount of labor and machinery is included in the variable costs. Marginal cost is calculated from how much additional cost is used to pay for new labor and to buy one unit of the new machine. These costs will add to the total cost of production. While kitchen costs are fixed and constant, they do not affect production costs.

From Ana’s case example, the way to calculate marginal costs is as follows:

Total production costs, before there is an additional request = IDR 5 million
After additional requests come in, additional raw material costs = IDR 200 thousand
Labor wages = IDR 1 million

So that means, there is a change in total production costs of IDR 5 million + IDR 200 thousand + IDR 1 million = IDR 6,200,000

There is also, the number of production which was originally 20, then increased by 50. So, the change in the number of production is 50 – 20 = 30.

That way, the marginal cost is IDR 6,200,000 / 30 = IDR 206,667. So, to maximize profit, Ana has to sell her cakes for more than IDR 206,667 per piece.

## Closing

That is an explanation of the notion of marginal cost or marginal cost. It can be concluded that the marginal cost is an additional cost that must be incurred by the company to make each additional unit of business product that will be produced by the company.

In order for the company to obtain the marginal cost, it can be determined by using the formula for the change in cost divided by the change in quantity.

It should be noted that marginal revenue and marginal cost must always have the same amount. In this way, the company’s profits will be maximized.

When the calculation process has been carried out with the formula above, the company can find out the amount of output value that is capable of producing the highest profit.