What is marginal cost?

Marginal cost refers specifically to the increase in total cost that arises when one additional unit of a good or service is produced. This concept is crucial for understanding production decisions, as it helps businesses determine the most efficient level of output. For example, if producing five units costs $100 and producing six units costs $120, the marginal cost of producing the sixth unit is $120 - $100 = $20.

Understanding marginal cost allows companies to make informed choices about pricing and production: they will typically continue to produce additional units as long as the selling price is higher than the marginal cost. This relationship is vital in maximizing profit since it ensures that resources are allocated efficiently.

In contrast, total cost measures overall expenses, average cost reflects the per-unit cost, and fixed cost pertains to unchanged expenses regardless of production level, none of which capture the incremental decision-making factors that marginal cost does.