Marginal+Cost

**Marginal Cost Defined**
Marginal cost is also known as incremental cost or differential cost. A simple definition of marginal cost (MC) would be, "The change in total costs arising from a change in the managerial control variable" (Baye, 2006). According to the Blackwell Encyclopedic Dictionary of Managerial Economics "The marginal cost is the change in total costs due to a unit (or incremental) change in output. That is, for discrete changes in output, marginal cost is given by...where MC is the marginal cost, δTC is the change in total costs, and δqis the change in output. In the short run, fixed costs do not vary with output, so marginal costs can also be written as:... where δTVC is the change in total variable cost. If the total cost function is known or has been estimated, marginal cost would be the derivative of total costs with respect to output" (p135, 2005).

Simply put: //Marginal cost is the change in total cost that arrises due to the production of one additional unit or can be seen as the derivative of total production costs with respect to the level of output.//

There are several formulas for Marginal Cost: MC(Q)=a + 2//bQ + 3cQ(squared)// It can also be said that MC(Q)=dC/dQ More simply put MC=change in Cost/change in Quantity

**Marginal Cost's Implications**
As firms grow larger and larger, it becomes increasingly difficult for a firm to manage the organization costs, as a product of this growth the marginal costs tend to rise as production increases beyond a certain point. Marginal costs can also rise due to technological reasons of resource limitations especially when production is influenced by these two factors. An expample of this can be seen in the US auto market today. Cleaner burning cars are wanted so the government imposes emission standards that must be met in order to drive a vehicle. Companies simply remove their highest emission vehicles and put in a hybrid model to meet the fleet emission goal. As the emission standards get higher and higher the costs of finding ways to reduce emissions get more and more expensive (ethanol engines, cleaner fuel, hybrid engines, electric engines) and the marginal cost to the company increases.

Marginal Cost also related directly to Average Total Costs(ATC) and Average Variable Costs(AVC). When marginal cost is below and average cost curve, the average decreases. When the marginal cost is above the average cost curve, the average is increasing. Marginal cost is also directly linked to Marginal Product. When marginal product is at its peak, marginal cost is at its lowest. At some point, marginal cost decreases as units of output increase when variable factors are added. At the same point, marginal product begins to decrease as additional units of a variable factor are added to a fixed factor (law of diminishing returns).

Marginal Cost with Economies of Scale http://www.answers.com/topic/marginal-costs

Marginal Cost with Diseconomies of Scale http://www.answers.com/topic/marginal-costs

Marginal Cost Pricing: http://www.economyprofessor.com/economictheories/marginal-cost-pricing.php

Marginal cost curves can be a variety of different shapes depending on the cost of producing the additional output. One common shape dipicts a curve that is decreasing over a quantity, but then it increases as the cost per additional unit increases. The curve looks like this:

The marginal cost in the next graph is MC = 2 + 0.5Q. In this example, each additional output costs the company 50 cents and the graph is below. The orange line represents the marginal cost curve and the blue line is the price.



Many times in story type problems the marginal cost will be given at a fixed rate to simplify the problem. In this instance, the marginal cost curve will be a horizontal curve (similar to the blue horizontal line in the graph above).

Marginal Cost Real World Examples:
The incremental cost of producing another CD after the initial recording has been made will be substantially less than that of the first CD. Similarly, copies of books and other print materials have low marginal cost in comparison to the first book or printed material produced. In light of the recent Earthday and upcoming Arbor day, take this last example: the cost of an producing apples after the tree has been planted and is producing fruit is lower than a newly established apple grower. Both require costs, however, establishing a new tree takes more effort and supplies than maintaining an existing tree. Therefore the fixed costs are equal to the purchase of the tree itself, plus the variable costs would be the amount of fertilizer, stakes, tree wrap and mulch required. If the tree already exists, a substantial amount of expenses do not apply. Therefore the first few products (be it apples, CD's or books) typically have a higher marginal cost associated with them. However, the apple tree's supply is not infinite and if more apples than the grower could provide were demanded, more trees would need to be planted, hence the marginal costs graphical 'swoosh'.

TEST Questions:
1. Examine this table. How many DVDs should Tina rent if the price is $4.00


 * __DVDs Rented__ || __Marginal Benefit of Renting a DVD__ ||
 * 1 || $6.00 ||
 * 2 || $5.50 ||
 * 3 || $4.50 ||
 * 4 || $3.50 ||
 * 5 || $2.00 ||
 * 6 || $1.50 ||

a. 3 b. 4 c. 5 d. 6

__The answer is 3 DVDs (a) because at that level the marginal cost is less than the marginal benefit. If Tina rented more than three DVDs then her marginal benefit would be less than her marginal cost.__

2. Which of the following is true at the point where diminishing returns set in? a. Both marginal product and marginal cost are at a maximum b. Both marginal product and marginal cost are at a minimum c. Marginal product is at a maximum and marginal cost is at a minimum d. Marginal product is at a minimum and marginal cost is at a maximum

__Answer: Marginal cost is at a minimum and marginal cost is at a maximum. As all the variable units needed are already in use and no further variables need be added marginal costs will decrease. Marginal product as a result will increase at this point because less money is invested in variables therefore profits will be greater. In other words, since the definition of marginal product is change in output/change in variable input, the denominator is decreasing resulting in larger marginal product__.

3. In a perfectly competitive industry, at what output are profits maximized? a. MC>MR b. MR>MC c. MC=MR d. MR>AVC

__Answer: In a situation where an industry is in perfect competition, firms maximize profits when they product where MC=MR.__

4. In a competitive industry, is it necessary for a firm's MR > AVC? a. No b. Yes c. Does not matter d. We don't have enough information __Answer: Yes, it is necessary for this firm to have MR > AVC. If MR is less than AVC then the firm would shut down. As long as MR = MC and the firm is covering their variable costs, they should keep running.__