What Is Marginal Cost? Formula and Examples
By Markets & Investing DeskUpdated Nov 10, 2026
Definition
Marginal cost is the change in total cost from producing one more unit of output. It measures the cost of the next unit rather than the average of all units already made.
Key takeaways
- Marginal cost equals the change in total cost divided by the change in quantity produced.
- In the short run, marginal cost comes entirely from variable costs, because fixed costs do not change with output.
- The marginal cost curve typically falls at first, then rises as a facility nears capacity and diminishing returns set in.
- A profit-maximizing firm expands output until marginal cost equals marginal revenue.
- Marginal cost differs from average cost and from marginal costing, a management accounting method.
Marginal cost is the change in total cost that results from producing one more unit of output. If making 1,000 units costs a business $50,000 and making 1,001 units costs $50,040, the marginal cost of that last unit is $40. In economics, marginal cost is the cost “at the margin”: it measures the next unit, not the average of all units already made, and it is the figure a producer compares with the extra revenue that unit would bring in.
What marginal cost means in economics
“Marginal” in economics means incremental: the effect of one more unit, hour or dollar. Applied to production, marginal cost answers a narrow, practical question: if we make one more, how much more do we spend?
Because it looks forward, marginal cost includes only costs that actually change with the decision. Rent on a factory that is already leased, insurance and salaried management usually do not change when output rises by one unit, so they are not part of it.
The marginal cost formula
The general formula is:
Marginal cost (MC) = Change in total cost (ΔTC) ÷ Change in quantity (ΔQ)
Total cost is fixed cost plus variable cost. Since fixed cost does not change in the short run, the change in total cost equals the change in variable cost, which gives an equivalent version:
MC = Change in variable cost (ΔVC) ÷ Change in quantity (ΔQ)
Costs to include in ΔVC are those that rise or fall with output:
- Direct materials and components
- Direct labor, including overtime and extra shifts
- Production supplies and packaging
- Energy used in production
- Additional maintenance caused by heavier use
- Per-unit freight, commissions or royalties
When a business changes output in batches, the formula gives an average marginal cost per unit across the batch. When the change is a single unit, it gives the marginal cost of that unit exactly.
Marginal cost with calculus
If total cost is written as a function of quantity, marginal cost is its first derivative: MC = dTC/dQ. Take a hypothetical cost function TC = 1,000 + 20Q + 0.5Q², where $1,000 is fixed cost. Differentiating gives MC = 20 + Q. At an output of 50 units, marginal cost is $70.
The discrete calculation comes close: TC rises from $3,250 at 50 units to $3,320.50 at 51 units, so the 51st unit adds $70.50. The derivative measures the rate of change at a point, while the discrete version measures a full one-unit step.
The area under the marginal cost curve from zero to a given output equals total variable cost at that output; fixed cost is excluded because it is incurred even at zero output. MC × Q equals variable cost only when marginal cost is constant. If MC rises with output, MC × Q overstates variable cost, because earlier units were cheaper to make than the last one.
Example of marginal cost
Consider a hypothetical bakery with fixed costs of $500 per day (rent, equipment leases, insurance). It bakes in batches of 100 loaves, and its daily total cost at each output level is shown below.
| Loaves per day | Total cost | Marginal cost per loaf (for that batch) | Average total cost per loaf |
|---|---|---|---|
| 0 | $500 | n/a | n/a |
| 100 | $800 | $3.00 | $8.00 |
| 200 | $1,050 | $2.50 | $5.25 |
| 300 | $1,350 | $3.00 | $4.50 |
| 400 | $1,750 | $4.00 | $4.38 |
| 500 | $2,350 | $6.00 | $4.70 |
Going from 300 to 400 loaves raises total cost by $400, so marginal cost over that batch is $400 ÷ 100 = $4.00 per loaf. The next batch costs $600, or $6.00 per loaf.
The pattern reflects what happens inside the bakery. Early on, staff settle into routines and the ovens are already hot, so the second batch costs less per loaf than the first. By the fifth batch, the bakery is paying overtime, running ovens past their efficient range and perhaps renting extra cold storage.
Now suppose the bakery sells to wholesalers at a market price of $5.00 a loaf, so each extra loaf brings in $5.00 of marginal revenue. Batch four costs $4.00 per loaf, so it adds to profit; batch five costs $6.00 per loaf, so it reduces profit. At 400 loaves, profit is $2,000 − $1,750 = $250. At 500 loaves, it falls to $2,500 − $2,350 = $150. The bakery is still profitable at 500 loaves, yet the last 100 loaves lost $100 between them.
The marginal cost curve
Plotted against quantity, marginal cost typically forms a U shape. It declines at low output because fixed inputs are underused and each added input makes the operation more productive. It then rises under the law of diminishing marginal returns: with a fixed plant, each additional unit of labor or materials adds less output than the one before, so each extra unit of output takes more input to produce.
By the arithmetic of averages, marginal cost below average total cost pulls the average down, and marginal cost above it pulls the average up. So the marginal cost curve crosses the average total cost and average variable cost curves at their lowest points. In the bakery table, the $4.00 batch is below the $4.50 average at 300 loaves, so the average keeps falling; the $6.00 batch is above the $4.38 average at 400 loaves, so the average rises to $4.70.
How marginal cost is used
Choosing output. The profit-maximizing rule is to produce where marginal revenue equals marginal cost. Below that quantity, an extra unit adds more revenue than cost; beyond it, an extra unit costs more than it earns. In a perfectly competitive market, marginal revenue equals the market price, so the rule becomes price equals marginal cost, and the rising part of the marginal cost curve (above average variable cost) is the firm’s short-run supply curve.
Pricing and special orders. Marginal cost sets a short-run floor for accepting additional business. An offer for extra units above their marginal cost increases profit if the plant has spare capacity and the deal does not force lower prices on existing customers. In the long run, prices also have to cover fixed costs.
Capacity decisions. A sharply rising marginal cost signals that the current facility is near its limit. That can justify comparing the cost of overtime and outsourcing with the cost of a new line or building, which would shift the whole cost structure.
Economies of scale. Falling marginal cost is one way economies of scale show up. Software, digital media and other businesses where an extra copy costs almost nothing can have marginal costs near zero, which shapes how they price and how quickly they can grow.
Marginal cost vs. related terms
Average cost. Average total cost is total cost divided by total units. It describes the cost of everything produced so far. Marginal cost describes only the next unit. The two are equal only at the bottom of the average cost curve (or when marginal cost is constant and there are no fixed costs).
Variable cost. Variable cost is a total: everything spent on inputs that vary with output. Marginal cost is the change in that total per extra unit.
Marginal costing. In management accounting, marginal costing (also called variable or direct costing) assigns only variable costs to products and treats fixed costs as period expenses. Its key figure is contribution: sales minus variable costs, the amount each product contributes toward fixed costs and then profit. Contribution is not marginal cost; it is revenue minus marginal (variable) cost. Marginal costing supports internal decisions such as break-even analysis and product mix, while external financial statements under standard accounting rules generally use absorption costing, which allocates fixed production overhead to inventory.
Marginal resource cost. This is the extra cost of hiring one more unit of an input, such as one more worker, rather than the extra cost of producing one more unit of output.
Limitations of marginal cost
- Hard to measure precisely. Businesses with shared machines, staff and overhead across several products have to estimate which costs truly vary with each one.
- Costs move in steps. Real costs often jump rather than change smoothly: a second shift, a new machine or another delivery truck adds a lump of cost at a specific output level. A smooth curve hides those thresholds.
- Short-run focus. Marginal cost assumes some inputs are fixed. Over longer horizons every cost becomes variable, and decisions based only on short-run marginal cost can underfund capacity, maintenance or product development.
- Unstable inputs. Changes in raw material prices, wages and technology can shift the curve quickly, which limits its use for long-range plans.
- Ignores fixed costs by design. Pricing near marginal cost can look profitable on each order while the business fails to cover rent, salaries and debt.
FAQs
Does marginal cost include fixed costs?
Not in the short run, since fixed costs are the same whether the next unit is made or not and cancel out of the change in total cost. If producing more requires a new fixed commitment, such as leasing an extra machine, that cost becomes part of the marginal cost of the expansion.
The Bottom Line
Marginal cost matters to any producer deciding whether to make more, accept a special order or expand capacity. Output should grow only while each extra unit brings in more revenue than it costs, which is the point where marginal revenue equals marginal cost. Prices near marginal cost can work in the short run with spare capacity, but over time revenue also has to cover rent, salaries and other fixed costs.
