What Is the Role of Marginal Cost in Economics?

Jim B.
Jim B.
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The importance of the concept of marginal cost in economics is that it helps firm managers decide if production costs are staying in line with the profit reaped from production. Marginal cost is defined as the amount of money it will cost a firm to produce a single unit of output. These costs vary depending upon the amount of production, often expending as larger orders are needed due to the law of diminishing returns. Firm managers must understand the concept of marginal cost in economics so that they can produce goods at an optimum level and mitigate production costs.

Cost control is crucial for any company that deals with large amounts of production. If these costs start to outweigh the amount of profit earned from the sale of goods, the company can end up in serious financial jeopardy. There are fixed costs which will be the same every time production is begun, and there are variable costs which will change depending upon the amount of production undertaken. Marginal cost in economics is a huge determining factor for these variable costs.

In the simplest sense, marginal cost in economics is the amount of money that is takes a firm to produce one extra unit of output. If the firm could always produce goods at the same cost no matter how many were produced, the marginal cost for one unit would remain unchanged. For example, a company that could produce a never-ending supply of a specific good at a cost of $10 US Dollars (USD) per item would have always $10 USD as the marginal cost. Using this example, the variable costs would simply be the amount of items produced multiplied by 10.

It is rare that a situation like the above example actually exists. For example, imagine that the cost for a firm to produce the first item in a production order is $16 USD, but, because of production vagaries, the cost of producing the second item in an order is only $12 USD. Since those costs change from item to item, marginal cost in economics is often represented as the average amount of marginal cost for each item. Using the example above, the marginal cost for the items produced would be $16 USD plus $12 USD divided by two, or $14 USD per item.

One crucial concept associated with the marginal cost in economics is diminishing returns. What this means is that the cost for items produced will often continue to rise as the order is expanded. Firms get less production for their money when this occurs, so they must be aware of the point when marginal costs start to rise to a significant amount.

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