Marginal Cost of Production
Candlefocus EditorLet's take a closer look at what these two values mean. Marginal cost is the increase in total cost a company experiences when producing one extra unit of a good or service. In contrast, marginal revenue is the revenue a company earns by producing one extra unit of a good or service. It is the benefit a company receives from the sale of the additional unit.
When producing, there are two types of cost that come into play: fixed costs and variable costs. Fixed costs are those that are set before the production process, and do not change regardless of production levels. Examples of this type of cost include rent for the premises, insurance, and interest payments. Variable costs are those that are directly related to the production level. Examples of this type of costs are raw materials, wages and utility bills.
Increasing the production level will reduce a company's unit cost of production through economies of scale, since the total fixed cost can be shared among more units. This can help improve its overall profitability. Additionally, a company must also be aware of its variable cost, so that the marginal cost of production is not too high.
The principle of marginal cost of production states that the company should produce until MR equals MC. This is where a company maximizes its profit by taking into account both fixed and variable costs. If production is increased beyond this level, variable costs will increasing, resulting in MC exceeding MR and profits declining.
A company also has to be mindful of step costs, which are costs incurred when changing production levels. Step costs occur when different machinery or storage space are needed in order to produce more units of a good or service.
To sum up, marginal cost of production is an important concept for any business as it helps guide decisions about how to maximize profits. Companies should produce until MR equals MC, and be aware of their fixed and variable costs as well as step costs when increasing production. By properly understanding and considering marginal cost of production in the decision making process, companies can maximize profits and optimize production.