Accounting Dictionary

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Marginal Cost

Definition: Marginal cost is the cost to create one more unit of a product. In a highly automated environment, this incremental change is likely to be solely the material cost of a product; in a less automated environment, it may also include the cost of the labor needed to create the product.

For example, it costs $20,000 to produce 50 units of a green widget, with most of the cost associated incurred during the setup of the production equipment at the beginning of the production run. It costs $20,100 to produce 51 units of the green widget, which means that the marginal cost of the next unit of production is $100. The average cost of producing 51 units of the green widget is $394 ($20,100 divided by 51 units). Given the large disparity between the marginal cost and the average cost of the green widget, you must be very careful about the uses to which you put these numbers.