Marginal cost of production is an economics term that refers to the change in production costs resulting from producing one more unit. It is most often used among manufacturers as a means of identifying an optimum production level.
The formula for marginal costs of production is:
Change in total production costs/Change in total quantity produced
The marginal cost of production is best used to determine when a company can reach an economy of scale to optimize production and overall operations.
Marginal costs of production will keep going down as production rises until the company has to incur more costs to produce more products. For instance, it may need to buy another machine, add warehouses or buy more materials. At that point, the next unit produced will have a higher marginal cost of production.
Utility of marginal costing:
- Helps in determining the volume of production
- Helps in selection production lines
- Helps in deciding whether to continue or shut down.