How To Calculate Marginal Cost

How To Calculate Marginal Cost

The marginal cost is the additional cost to increase the production quantity. The marginal cost expresses the variation of the additional quantity of a product in a small way. This article will give you a complete guide about how to calculate marginal cost& all about the cost curve.

Cost curve 

Cost curves are the geometric representation of economic costs. They are one of the tools of political economy. The cost function of a firm and determine the optimal quantity of production (unit of output).

What is a cost curve?

The cost curve is the graphical representation of a Cartesian diagram of the production quantity’s total cost.

The types of cost curves 

There are different types of cost curves: the total cost curve, the average cost curve. The marginal cost curve, the variable cost curve, the short, medium, or long term cost curve. etc.

  • Total cost curve
  • Average cost curve
  • Marginal cost curve

Total cost curve 

When we talk about the cost curve in a general sense, we refer to the total cost curve that associates the total cost with production quantity. It has a typical U shape because the average variable cost function (CMV) is increasing with the number of units produced.

Marginal cost curve 

In addition to the total cost and average cost (unit cost) curve. The use of the marginal cost curve is frequent in microeconomics. The marginal cost (CM) curve measures the ratio of the change in total cost to a change in production quantity (ΔY).

The area under the marginal cost curve identifies the variable costs of production. Instead, it is above the average in the section where average costs increase. The equality between the average cost and the marginal cost determines the efficient size of the firm.

Marginal cost: definition

The marginal cost measures the company’s cost to produce an additional unit of a good or service to deliver a unit greater. If the price does not equal the marginal cost, this implies that the firm could continue to produce, obtaining a higher profit. The firm should continue to produce until the price equals the marginal cost.

In the case of monopoly (there is only one producer on the market), there are low production volumes of the product and the application of a higher price. Therefore, the producer’s extra profit will be more than offset by the loss of consumer welfare. Fixed costs are independent of production volumes. If the company incurs fixed costs higher than the total costs, it can no longer match the marginal cost price: in this situation, the company would produce at a loss.

How to calculate the marginal cost: Formula 

From the formal point of view, the marginal cost is determined by the ratio between the change in total cost (ΔC) and the infinitesimal change in production quantity (ΔY). In formal terms, we can write.

CM: ΔC / ΔY

Marginal cost represents the change in cost, compared to a change in output Y.

The marginal cost could be defined as 1/PM, where PM is about to marginal productivity. Hence, marginal cost is the inverse of marginal productivity, understood as an increase in production (ΔQ), resulting from increases at the margin from the use of a certain production factor (Δxᵢ).

The marginal cost curve appears initially decreasing, in the presence of positive fixed costs, and subsequently increasing. In other words, the productivity of a firm is first increasing and, after reaching the maximum, it begins to decrease.

The marginal cost curve shows a decreasing feature: the use of additional production units allows better use of fixed assets. At this stage, the marginal product of the factors of production is growing. The marginal cost curve shows an increasing feature: each additional unit of use of the production factors worsens the production system’s efficiency.

NB: In the marginal cost curve, only variable costs are considered since fixed costs do not vary as the quantity produced varies (ΔY).CM marginal costs refer exclusively to the additional quantity of production (ΔY) and the increase in variable costs of production (ΔC) since the fixed costs do not change as the quantity of production varies.

How to calculate the marginal cost: Marginal cost graph 

Curve The marginal cost CM’s function can be represented on the Cartesian diagram by relating the marginal cost CM with the quantity of production Y. In this representation, the “U” shape of the marginal cost curve is strictly linked. To the marginal productivity of the factors of production.

The “U” -shaped trend of the marginal cost curve is determined by the marginal productivity of the production factors. The economic significance of the decreasing and increasing section of the marginal cost curve is as follows:

  • Descending stretch. In the initial phase, the marginal cost curve is decreasing. Since the use of additional units of production factors allows better use of the plant, the marginal product of the factors of production is growing at this stage.
  • Growing s. Each additional unit of use of the production factors worsens the efficiency of the plant. In this second phase, the marginal product of the

The permissible marginal cost

The effectiveness of a site is not measured by the site’s position in the TOP and not by the number of visitors, although most often, site owners track and pay for these very metrics. Such a payment model for promotion services is popular, such as payment for a targeted action performed by a visitor on the site. The maximum allowable cost of a targeted action (appeal, order, application) of a visitor on the site (CPL / CPO) is the cost that a company can afford in the current or projected situation.

The pay-for-target action model is attractive because the pay is post facto and, at first glance, has fewer risks. But there are two main risks worth noting:

  • To get more referrals, there is a possibility of paying more for referrals than is profitable for the business;
  • The risk of not getting the required number of hits because the business has offered too little price per action.

So the main question arises: “At what cost of the targeted action will such a model be profitable?” To do this, you need to determine the CPL / CPO and compare these indicators with the market offers.

What determines the maximum permissible cost of the targeted action?

  • Conversion of requests from the site into deals
  • Average transaction check
  • % of the marginal profit that the business receives from each transaction (excluding the costs of website promotion)
  • Part of the profit that the business is willing to pay to complete the transaction. What part of the margin profit is ready to spend to complete the transaction? 25%? fifty%? one hundred%? Or 150%? It depends on the likelihood of repeat sales to the attracted customer and the competition in the business’s industry.
  • Customer lifetime. Frequency of purchases and orders by the client.

How to calculate the marginal cost: maximum permissible cost

Let’s consider the definition of the acceptable How to calculate the marginal cost of action on the examples of two very different businesses – an auto center and a flower delivery service.

Example 1: How to calculate the marginal cost

AutoLeader using the landing page collects contact information for an application for a test drive. The number of calls per month – 16. Of the 16 who signed up for a test drive, only one person becomes a car buyer. Thus, the conversion of calls to transactions is 6.25%. The average check is 700,000 rubles. Let’s say that the% of the car dealership’s profit margin is 25%.

Let’s calculate the maximum allowable cost of the targeted action on the site.

  • Average bill 700,000
  • Margin profit 25% or 175,000
  • Allowable expenses for attracting a deal 20% of the margin or 35,000
  • Conversion of calls to deals 6.25%

C PL / CPO = 35,000 x 6.25% = 2187 for the targeted action

When talking about the cost-effectiveness of acquiring one customer, it is worth remembering the customer’s frequency of purchases. In the case of a car dealership, the frequency of purchases of a new car is average once every five years. Therefore, there is no point in agreeing on the cost of a visitor’s action on the site. Which is more than the maximum allowable.

Example 2: How to calculate the marginal cost

  • Flower delivery service “Dandelion.”
  • The target action for flower delivery will be ordering by filling out the contact information form.
  • Average bill 1,500
  • Margin profit 30% or 500

Allowable expenses for attracting the first client’s deal are 100% of the margin or 500 rubles. Those who once applied to the flower delivery service with good service and reasonable prices are highly likely to become regular customers.

Conversion of calls to transactions 90%

C PL / CPO = 500 x 90% = 450 per targeted action

We have considered how you can calculate the maximum allowable cost of a visitor’s action on the site. In practice, however, calculating this value can be much more difficult. Not every business knows the conversion of calls to deals. Monitors the frequency of calls from regular customers to the company. 

This makes it difficult to determine the cost of an action or makes it nearly impossible.

But there is another difficulty in promoting with payment for targeted actions – the discrepancy between the cost. That the business is willing to pay and the rate that the promoting companies offer, the reason for this may be high competition in the industry in which the business operates. Low demand on the Internet for the offered product or service. You need to either raise the rate or choose another model of payment for website promotion – promotion for a monthly fee.

How to calculate the marginal cost: Production Costs

CostsSince the firm derives its income from the difference between the revenues earned by selling the products and the costs incurred. So it is intuitive that it will be in the company’s interest to minimize costs. But what is the cost? In general, the cost, as we have already seen, can be defined: what you have to sacrifice to get something. So the total cost is all that the firm sacrifices to obtain production.

Total cost             

The two types of inputs – fixed and variable. That can be distinguished in the short term to correspond to two types of costs, similarly, fixed and variable. So the fixed costs are those which, to varying dimensions of the volumes of the product, remain unchanged. A typical example is the cost of the production plant or relative depreciation.

The most obvious examples are raw materials, energy, external processes. So it does not vary as it varies in quantity. The variable cost curve has a course that is steeper, then less steep. Then rapidly rising again (the inverse of curve 9.5a) under the law of diminishing returns.

Average cost

The average cost is given by the ratio between the total cost of production and the total output realized. For this same reason, the average cost is also defined as unit cost (CU ), i.e., the cost of a product unit. In the short term, where it is useful to distinguish the total costs between variable and fixed.

The marginal cost curve together with that of the average cost. For all levels of output to the intersection point’s right, the marginal cost is greater than the average cost. The shape of the curves is always the same for any business. The marginal cost curve is growing. At first, the marginal product of a single additional quantity is large: the practical reasons can be manifold.

For example, increasing the number of employees in a laboratory from 1 to 2 will allow you to activate previously idle resources and obtain the advantages inherent in labor division. The cost of an extra unit of product is low. But as the firm approaches full utilization of the production facilities, each new worker’s additional product will become smaller, and the marginal cost will increase faster and faster.

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