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What Are the Different Methods of Marginal Cost Analysis?

Osmand Vitez
Osmand Vitez

Marginal cost analysis provides a company with information on the changes in total cost when a company produces more. The process relies more on economics theory rather than a managerial accounting process. In short, marginal cost analysis includes all costs for producing one more or several more additional units. The different methods to do this include production-wide reviews, the marginal cost formula, and the average total cost formula. Each provides a different look at the process while using pretty much the same data.

A production-wide review is the most basic marginal cost analysis. In many ways, no major formula or mathematical process is necessary to really evaluate the situation. The process here is to determine each cost that will occur when a company decides to produce additional units. All costs required to increase production will result in an increase to total production costs from an economic standpoint. For example, the direct materials and direct labor are certainly additional costs; if the company has to build a new building, however, this also factors into the cost for these additional products.

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A slightly more involved step in marginal cost analysis is the use of a basic marginal costs formula. The classic formula here is the change in total cost divided by the change in quantity produced or output. Total cost in this formula represents both fixed and variable costs, with costs such as rent, depreciation, and property taxes being fixed and materials, labor, and utilities being variable. The change in total costs is total costs for higher production output less total costs for the previous production level. The result is the change in total costs from producing new units.

The change in quantity is a bit easier to determine. The formula is simply higher production output less the previous lower production output. Analysts can divide the change in total cost by the change in quantity to determine the marginal cost. The final result is the cost to produce one additional unit in marginal cost analysis.

Average total cost is similar to the previous formula, though it is more of a starting point for marginal cost analysis. The formula here is fixed cost plus variable cost divided by total quantity. This provides a baseline for measuring economic costs in a production activity. The formula can help prove the marginal cost and ensure the cost averages do not spike too far when producing additional units.

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