Marginal cost vs average cost

Definitions and explanations:

Marginal cost:

Marginal cost is the cost incurred for producing one extra unit of output. In other words, it is the total change in total cost that comes from producing one extra unit of output. The overall reason behind calculation of marginal cost is determining the extent to which the company is operating at or near economies of scale.

Marginal cost of production includes all the different costs that are associated with the varying level of output. For instance, it can be seen that if there is a need to build a new factory in order to produce more goods and services, the cost of building the factory can be considered as a marginal cost. Therefore, marginal cost directly varies with the overall volume that is being produced. Additionally, there are certain economic factors which impact marginal cost including informational asymmetries, and positive and negative externalities, transaction costs and overall price discrimination. However, marginal cost is not impacted by fixed costs, that are consistent regardless the level of output and volume.

Marginal cost is calculated using the following formula:

Marginal Cost = Change in Total Cost / Change in Quantity

Average cost:

Average cost can be defined as the production cost per unit. It is the total cost that is incurred on producing one unit of output. It takes into consideration both, fixed costs, as well as variable costs. The formula for calculating average cost is given below:

Average Cost = Total cost / Total output.

Alternatively, average cost can be calculated by adding fixed cost per unit, and variable cost per unit. The formula for calculating Fixed Cost per Unit, and Variable Cost per Unit, respectively are as follows:

Fixed cost per unit = Total fixed cost / Total output

Variable cost per unit = Total fixed cost / Total output

Calculation of average costs is the best way for an organization to be able to gauge its overall performance. Another important aspect in this regard is the fact that average cost is greatly influenced by the time period of production, which might factor in short-run, and long-run production timelines. Hence, short-run average costs, and long-run average costs both need to be factored in, in this regard.

Difference between marginal costs and average cost:

There are certain notable differences between marginal costs and average costs. They are given below:

Average cost is calculated by dividing total output by the total incurred costs, over a time period. However, marginal cost is calculated by dividing the change in total costs by the change in output.

The main aim of calculating average cost is to access the overall impact on total unit cost with respect to a change in output level. However, with marginal cost, the main aim is to find whether it is beneficial to produce the additional unit of goods.

The average cost curve, if graphically displayed can be seen to be downward sloping, because of the declining fixed cost. However, marginal cost curve is concave in nature, and changes with the subsequent level of output.

Average cost is used for interpretation when the topic of discussion is cost minimization. However, marginal cost is used for discussion when the objective is to maximize profits.

Average Cost is made up of two components, which are average fixed costs, and average variable costs. On the other hand, marginal cost is a separate cost unit, and therefore, it does not have any unit.

Marginal cost vs average cost – tabular comparison

A tabular comparison of marginal cost and average cost is given below:

Marginal Cost vs Average Cost
Definition
Cost incurred for producing one extra unit of output	Production cost per unit. It is the total cost that is incurred on producing one unit of output
Purpose
To determine the extent to which the company is operating at or near economies of scale.	To be able to gauge its overall performance of the company by considering both variable and fixed cost.
Formula
Change in total cost/Change in total output	Total cost/Total output
Assessment
Marginal cost assesses whether it is beneficial to produce an additional unit of good.	Calculated to assess the overall impact on total unit cost with respect to a change in output level
Curve
Marginal cost curve is concave in nature, and changes with the subsequent level of output.	Average cost curve is downward sloping, because of the declining fixed cost.
Objective
Used when the objective is to maximize profits	Used when the topic of discussion is cost minimization
Components
Separate cost unit, and therefore, it does not have any unit.	Includes two components i.e. average fixed cost and average variable cost.

Conclusion – marginal cost vs average cost

Marginal costs and average costs are both equally important tools of analysis that can provide a deep and a meaningful insight pertaining to the overall costing function of the business. Despite the fact that both these costs depict different things, yet it can be seen that their interpretation and final result leads to the exact same result, which is ensuring that they are able to increase the overall profitability of the company.

Additionally, these are metrics that can help organizations to make decisions in a much more informed manner. It directly highlights the areas which need greater attention, so that they are able to fix it, and duly ensure that they are able to increase profitability subsequently. Furthermore, calculation of these costs help on making some integral decisions pertaining to the overall business model.