Marginal cost is what you (or your company) will incur if you produce additional units of a product or service. It is possible that you have already found it under the nomenclature "cost of the last unit". You need to calculate marginal cost to maximize your own earnings. To perform this operation, divide the variation in cost by the variation in the quantity of the particular product or service.
Method 1 of 3: Determining Quantity Variation
Step 1. Calculate the level of production at which fixed costs start to vary
To calculate marginal cost, you need to know the total cost of producing one unit of what you sell. Fixed costs should be the same throughout the cost analysis, and it is necessary to find the level of production to which it would be necessary to increase them.
If you have a bakery and sell cookies, for example, ovens represent a fixed expense. If they have the capacity to prepare 1,000 muffins a day, this value would be the maximum amount of muffins to be considered in the marginal cost analysis. When producing more than 1,000 dumplings, the fixed costs would have varied because it would be necessary to purchase an additional oven
Step 2. Determine the range to be evaluated
You can calculate the marginal cost of each individual unit of product or service being sold. However, this is a useful step only if you tend to produce a few units a day. Otherwise, it may be useful to look at the variation in quantity as a factor of 10, 50, or even 100.
- Suppose, for example, that you run a spa that offers three to five massages a day. You want to know the marginal cost of booking an additional massage. In that case, it makes sense that your range is equal to one.
- If you do offer products, it might be helpful to look at larger variations in quantity. If the company produces 500 tools a day, for example, you might consider the marginal cost of producing 100 or 200 more, and so on.
if you're having difficulty determining the range of range to analyze, go for something smaller at first. If the marginal cost turns out to be extremely small, you can repeat the calculations with a wider range.
Step 3. Subtract the number of units in the first wave from the number in the second wave
Each interval constitutes a production batch. To determine the change in quantity, simply subtract the old quantity from the new one.
If the company produces 500 tools a day and you want to analyze the marginal cost of producing 600 of them, the change in quantity would equal 100
Method 2 of 3: Identify the variation in cost
Step 1. Calculate the total production costs
This value consists of the fixed and variable costs added up against a specific quantity of product or service units. Fixed costs are those that do not vary over the period analyzed. On the other hand, variable costs can change and even increase or decrease depending on circumstances.
- Capital expenditures, such as equipment, are usually fixed costs. The amount paid each month for a professional space rental would also be included in this category.
- Variable costs include monthly bills, staff salaries, and supplies used in producing the service or product. They get this name because they usually increase with the increase in production level.
- Calculate variable costs for each output level or production range. Add variable costs to fixed costs to get the total cost figure.
the total cost for each output level or production interval is the only one needed for calculating the marginal cost. You don't need to know which portion of the total cost is fixed and which portion is variable, although this is valuable information in other contexts.
Step 2. Determine the average cost of each unit
By knowing your total cost amount, you can determine the average cost of each unit of product or service being sold. At each output level or production range, just divide the total cost by the number of units.
- If the total cost to produce 500 tools is equal to BRL 500, for example, the average total cost per unit will be BRL 1. However, if the total cost to produce 600 tools is equal to BRL 550, the cost average total per unit will be R$0.92.
- You can also calculate average fixed cost and average variable cost.
although average cost values are not used to calculate marginal cost, they are values that can help you determine the best possible level of production to maximize gains with respect to the product or service being sold.
Step 3. Subtract the old cost from the new one to calculate the variance
Variation in cost is measured in the same way as variation in quantity. Subtract the costs for the smallest production range or output level from the costs relative to the largest. This amount equals the change in cost for that particular range.
If R$500 is needed to produce 500 tools and R$550 to produce 600 tools, for example, the variation in cost will be equivalent to R$50
Method 3 of 3: Determining Marginal Cost
Step 1. Divide the variation in cost by the variation in quantity
The formula used to calculate marginal cost is the change in cost divided by the change in quantity. Once you have determined both values, you can use them to calculate the marginal cost without much difficulty.
Suppose you want to calculate the marginal cost of producing 600 tools a day, for example, compared to 500 tools a day. The variation in cost will be equivalent to R$50 and the variation in quantity to 100. Thus, it is concluded that the marginal cost will be equal to R$0.50
Step 2. Repeat calculations for additional intervals
Marginal cost can increase or decrease as you continue to add units of production. Finally, its aim is to produce the service or product at the lowest possible marginal cost.
- Suppose, for example, that the marginal cost of producing 600 tools compared to 500 tools is equal to BRL 0.50. However, the marginal cost of producing another 100 tools (totaling 700) will be only BRL 0, 32. Producing 700 tools in this way is more cost-effective than keeping to 500.
- Marginal cost does not always go down, and at some point it will start to go up. If you need to hire a new member for your team in order to produce 800 tools, the marginal cost may rise to 0.52 reais.
Step 3. Enter data into a spreadsheet to generate cost curves
By putting your data into a spreadsheet, you can create charts that visually display the marginal costs of each production range or output level. The marginal cost curve usually has a "U" shape. This curve shows up at the beginning, with costs of additional units presenting higher values in their production.
Entering the data into a curve gives you the possibility to stipulate what level of production would be the most cost-effective for your company
if you have calculated the total costs and the average variable costs, you can also generate their respective cost curves. They will have the familiar "U" shape, but with the curve manifesting further along the line than in the case of marginal cost.