Definition of Marginal – In business activities, there are five types of costs associated with the production process, namely fixed costs , variable costs , total costs , average costs, and marginal cost (marginal cost). Each type of cost has a different meaning, function and calculation. Among the various types of costs, marginal costs are the most important to understand in order to maximize profits.
Marginal cost is an important aspect that must be considered in the production of goods. Of course, companies must really know how much it costs to be involved in a particular production cycle, and it is very important to be able to plan the price and production of goods. Furthermore, marginal cost is the decrease or increase in total cost due to the addition or reduction of one unit of by-product.
In economic terms, marginal cost is the change in total cost of production that results from producing or making one more unit. As an entrepreneur, you definitely need to calculate production costs, not only that, you also need to take into account all other cost factors such as marginal costs. In simple terms, marginal cost is the decrease or increase in the total cost of a business.
Marginal costs usually result from adding or subtracting one more unit of output. But apart from that, marginal cost is also related to marginal revenue. Why is that? Usually, to maximize profits, a firm will increase its output until it reaches a point where marginal cost equals marginal revenue. In economic terms, marginal revenue is called MR ( marginal revenue ) and marginal cost is called MC ( marginal cost ).
Whether you work in accounting, operations or management, it’s important to know how to optimize your team’s performance and productivity. To streamline production and maximize profits, you need to understand how marginal cost works.
Remember that almost everything you do in your business has a cost. Whether it’s time, money, effort, or whatever, you pay the price. But what if you set a production limit and need to produce more than you set? You find what’s called marginal cost.
In this article, Sinaumedia will explain what marginal cost is, how to calculate it using the formula, and everything you need to know about marginal cost.
Definition of Marginal Cost
Marginal cost is the additional cost of producing one more unit of output than would normally be produced. Marginal cost can also be understood as the cost which describes the rate at which the total cost of a product changes. Another interpretation is to predict that economic costs will change if production also changes.
Here’s an example. A company produces 1500 units of goods. The exit cost is 1501 units. This additional amount is called the marginal cost.
If production costs are fixed and do not change with additional costs, then the marginal cost is a picture of how variable costs change.
Making business decisions can be done by looking at the marginal cost. For example, management needs to decide something related to the allocation of resources in the production process.
For example, management must decide whether to establish a productivity policy. To do this, they need to look at the marginal cost and compare it to the marginal cost realized by one additional unit of output. The goal is that the company can make the right decisions regarding increasing production volume.
This is the main objective of the marginal cost analysis so that the company can produce more efficiently. In addition, companies can optimize their operating systems.
For the calculation of marginal costs can be obtained from fixed production costs and variable costs. Variable production costs will always be included in marginal costs. During this time, fixed costs will be taken into account if necessary to manufacture additional products.
For example, a company spends 1 million to print an image on 5 shirts. So, to be able to print 11 shirts, they need an additional fee of 10 thousand. For that, the marginal cost is 10 thousand rupiah.
Marginal costs (marginal costs) are very important for making business decisions where a management must be able to provide decisions about allocating resources in the production process.
Marginal Cost Formula
The marginal cost formula is often used in calculating each company’s margin costs. The following is the marginal cost formula:
MC = ∆TC / ∆Q
Information:
MC= Marginal Cost
∆TC= Change in total cost (total change in cost)
∆Q= Change in the quality of goods and services (total change in quantity)
Stage of Calculating Marginal Cost
After discussing the marginal cost formula, you need to know what costs to include.
Marginal costs include variable costs and fixed costs. Variable costs include the labor and materials used to manufacture your final product. Fixed costs include costs such as administrative work and overhead.
Fixed costs do not change if you increase or decrease production levels. So you can spread your fixed costs over more units as you increase output (and we’ll get to that later).
Now that you know the difference between types of costs, let’s look at the marginal cost formula and how to find marginal cost. Your marginal cost is the change in total cost divided by the change in quantity.
From the discussion above, there are 3 stages in calculating marginal costs, namely:
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Fee Changes
Cost change is the increase or decrease in production costs at each level of production and in each period, especially when production demand is more or less.
If the production of these additional units employs one or two workers and increases the cost of materials, it is certain that the total cost of production will change.
Now, to determine change costs, subtract the existing production costs on the first production from the subsequent production costs when there is an increase in production.
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Quantity Change
Of course, when you want to calculate marginal cost, you need to know the total cost required to produce one unit of output produced by the business. Total fixed costs must be the same during the cost analysis. Therefore, the first step in calculating marginal cost is to determine when fixed costs will change.
At different levels of production, the quantity of goods produced increases or decreases. In terms of determining changes in quantity, a calculation is made of the quantity of goods produced in the first production, then reduced by the volume of production carried out in the next production.
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Marginal Cost
Marginal cost is the cost required to produce one additional unit of product. In other words, calculating the marginal cost is done to find out the increase in costs required for each additional unit of production. The total marginal cost is obtained by dividing the required production costs by the change in product quantity.
How to Calculate Marginal Cost
Step 1: Calculating the Change in Quantity
Of course, to be able to calculate marginal cost, you need to know all the costs involved in creating the product or service a company can produce. As explained briefly earlier, this total cost includes fixed costs as well as variable costs.
Fixed costs must be the same in all cost analyses. For this reason, the first step in calculating marginal cost is to determine when fixed costs will change.
Step 2: Calculating Cost Change
After knowing the change in the amount of production, the next step is to calculate the change in costs. Well, the change in cost itself can be obtained by subtracting the total cost of the old production by the cost of the new production.
The total value of production costs can be obtained by adding up fixed costs and variable costs. Fixed costs are costs that do not change in value over the period you are evaluating. These fixed costs include tooling costs, space rent, etc.
Because the variable cost itself will generally increase along with the increase in production costs. These variable costs include the cost of materials, staff salaries, equipment, etc. To get your own variable cost, you can derive it from the range of production quantities.
Once you know the value of fixed and variable production costs, it is easy to derive the full cost of production. In addition, the value of the variable costs of production will also be obtained.
After knowing the value of fixed and variable production costs, the total cost of production is obtained. The value of variations in production costs will also be obtained.
Step 3: Calculating Marginal Cost
Marginal cost is the cost required to produce one more unit of output. That is, marginal cost can be taken to find out whether an increase in cost is required for each additional output.
To find marginal cost, you can find it by dividing the change in production costs by the change in output. You can also get it by using the formula MC = TC/Q, where MC is marginal cost or marginal cost, TC is the change in cost and Q is the change in quantity produced.
Marginal cost is obtained by dividing the change in production costs by the change in the amount of output. You can also use the formula MC = TC / Q. MC is marginal cost (marginal cost), TC is the change in the cost of production, and Q is the change in the quantity produced.
Example of Calculating Marginal Cost
Once you know the marginal cost formula, you can easily understand how to calculate the marginal cost of your company. Know how to calculate marginal cost. This is an example of possible marginal cost.
Example 1
From the example of the question of marginal costs, there is a company PT. Murni costs as much as Rp. 400 million to produce 1000 units of tables. When the total production has reached 2000 units, the company will incur a cost of Rp. 600 million to produce it.
From the example of the marginal cost problem above, what is the total marginal cost of producing the table?
Is known:
∆TC = Rp. 600 million – Rp. 400 million
∆TC = Rp. 200 million
∆Q = 2000 units – 1000 units
∆Q = 1000 units
Completion:
MC = ∆TC / ∆Q
MC = Rp. 200,000,000 / 1000 units
MC = Rp. 200,000 per unit
Then the marginal cost of producing the table is Rp. 200,000. Which means that the total cost has increased by Rp. 200,000 with the production of one table.
As a business owner, it is very important for you to track and understand how different costs change with changes in volume and production rates. Of course, this cost allocation largely determines the price of services and helps with many other aspects of the overall business strategy.
Example 2
Satrio Anggoro owns a bakery in downtown Jakarta. It has some fixed costs such as rent and the cost of purchasing machinery, tillage and other equipment.
It then has some variable costs such as personnel, utility bills, and materials. During its first year of operation, its total costs amount to 100,000,000, of which 80,000,000 are fixed costs and 20,000,000 are variable costs.
He sold 50,000 items, earning 200,000,000. In the second year of operation, the total costs increased to 120,000,000, of which 85,000,000 were fixed costs and 35,000,000 were variable costs. He sold 75,000 items, earning 300,000,000.
As we can see, fixed costs increase because new equipment is needed to increase output. Variable costs also increase as more labor and materials are required.
The two of them add up to a 20,000,000 surcharge. At the same time, the quantity of goods produced and sold increases by 25,000, so this marginal cost is calculated by dividing the additional cost (20,000,000) by the increased quantity (25,000), to get the original price of 0.800 per unit.
Example 3
Saleh Nur owns a textile company that makes 200 ballet skirts every year, costing 15,000,000 to make.
She began experiencing increased demand, with an additional 20 ballet skirts being requested.
He calculated the materials and other costs and found that he needed an additional 2,000,000 to make an additional 20 ballet skirts.
This marginal cost can then be calculated by dividing the cost by the quantity. So 2,000,000 / 20, which equals 100,000 ballet skirts. In order for her to make a profit, she therefore had to ask customers to pay more than 100,000 for each ballet skirt.
Example 4
Marginal cost = change in total cost of production / change in the amount of production
From the example of the case of Ibu Dewi’s cake shop above, for example, the total cost of production before there was an additional request was IDR 5,000,000 to buy raw materials and pay for labor wages. When there is an additional request, there is an additional cost of Rp. 200,000 for raw materials and Rp. 1,000,000 for labor costs. This means that there is a change in the total production cost of IDR 5,000,000 + (IDR 200,000 + IDR 1,000,000) = IDR 6,200,000.
As for the amount of production that was originally 20, it increased after there was an additional request of 50. So the change in the amount of production is 50-20 = 30.
Thus, the marginal cost is IDR 6,200,000/30 = IDR 206,667.
So, in order to maximize profit, Mrs. Dewi had to sell the cakes for more than Rp. 206,667 per unit.
Average Cost and Marginal Cost Curves
U-shaped marginal cost curve. In the analysis of marginal costs to determine the optimal level of production output, a comparator is also needed in the form of an average cost curve.
When production volume increases, the cost per unit decreases. Marginal cost is lower than average cost. This is called economies of scale. Production has reached its optimum volume when the combined production quantity and unit cost reach the bottom of the U on the graph. It is the most efficient and profitable level of production so that a business can maximize its profits.
An increase in output causes an increase in marginal cost. The cost of each additional unit of production becomes more expensive than the final unit of production. Marginal cost is greater than average cost. This is called the economy of scale error.
This means that production costs will be higher because they have already exceeded the most profitable and efficient production level. After this size is reached, the company may not add production units because it can cause losses.
Economies of Scale and Diseconomies
Performing marginal cost calculations will be very helpful in determining whether workflows need to be changed continuously. In general, when there is an increase in production volume, companies will be able to achieve higher economies of scale, in which marginal costs can be reduced.
This economy of scale is achieved through the specialization of human resources and the use of more efficient production machines. An increase in production volumes will also allow manufacturers to get very significant discounts when purchasing raw materials or raw materials.
But eventually, at some point, an imbalance of scale will emerge, whereby costs will increase more than output increases. This problem will occur frequently because, for example, there are overlapping jobs, meaning more workers are on production machines.
An increase in the number of workers will also make work unable to coordinate better. Even the price of goods or raw materials will be more expensive because all domestic supplies run out.
In general, a firm operates at maximum output when marginal cost equals the number of units measured by average cost. If you plot it on a graph, marginal cost will form a U-shaped curve.
Closing
Thus, Sinaumedia’s explanation of marginal costs. We can conclude that marginal cost is the additional cost a firm incurs to be able to produce each unit of commercial product that it can produce.
To get the marginal cost can be known by using the formula Change in cost divided by change in quantity. Every business should know that marginal revenue and marginal cost must always be the same for maximum profit. After you do the calculation according to the above formula, the company should be able to determine which output value is most likely to generate profits.