Definition and Explanation:
Marginal means Extra. Marginal cost is defined by CIMA as “the cost of one unit of a product or service which would be avoided if that unit were not provided or produced.”
In simple words we can say, “Marginal cost is cost of producing an additional unit”. Similarly, marginal revenue is the revenue earned by the sale of an additional unit. The theory of marginal cost is explained in “A report on Marginal Costing” published by CIMA, London is as follows:
“In relation to a given volume of output, additional output can normally be obtained at less than proportionate cost because within limits, the aggregate of certain items of cost will tend to remain fixed and only the aggregate of the remainder will tend to rise proportionately with an increase in output. Conversely, a decrease in the volume of output will normally be accompanied by less than proportionate fall in the aggregate cost”.
This is further explained with the help of following illustration:
(1) If a business cost of producing 1000 units at a total cost of $4000 and total cost increases to $4003 by producing one additional unit of output then the marginal cost of producing an extra unit will be $3 ($4003 – $4000).
(2) By extending the example, if we assume that the output is increased from 1000 to 1030 units with the total new cost of $4040, the average marginal cost per unit will still be $3.00. It is calculated in the following:
Formula to Calculate Marginal Cost: