marginal cost

Examples of marginal cost in the following topics:

• Marginal Analysis

  • Pricing decisions tend to heavily involve analysis regarding marginal contributions to revenues and costs.
  • In business, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output is known as marginal-cost pricing.
  • Businesses often set prices close to marginal cost during periods of poor sales.
  • Alternatively, if marginal revenue is less than the marginal cost, marginal profit is negative and a lesser quantity should be produced.
  • At the output level at which marginal revenue equals marginal cost, marginal profit is zero and this quantity is the one that maximizes profit.

• Profit

  • This will often require them to revise sales targets as prices and costs change.
  • An alternative perspective relies on the relationship that, for each unit sold, marginal profit (Mπ) equals marginal revenue (MR) minus marginal cost (MC).
  • Then, if marginal revenue is greater than marginal cost at some level of output, marginal profit is positive and thus a greater quantity should be produced, and if marginal revenue is less than marginal cost, marginal profit is negative and a lesser quantity should be produced.
  • At the output level at which marginal revenue equals marginal cost, marginal profit is zero and this quantity is the one that maximizes profit.
  • Since total profit increases when marginal profit is positive and total profit decreases when marginal profit is negative, it must reach a maximum where marginal profit is zero - or where marginal cost equals marginal revenue - and where lower or higher output levels give lower profit levels.

• Transfer Pricing

  • Double marginalization is when both divisions mark up prices in excess of marginal cost and overall firm profits are not optimal.
  • From marginal price determination theory, the optimum level of output is that where marginal cost equals marginal revenue.
  • But marginal cost of production can be separated from the firm's total marginal costs.
  • It can be shown algebraically that the intersection of the firm's marginal cost curve and marginal revenue curve (point A) must occur at the same quantity as the intersection of the production division's marginal cost curve with the net marginal revenue from production (point C).
  • From marginal price determination theory, the optimum level of output is where marginal cost equals marginal revenue.

• Profit-Maximization Pricing

  • Any costs incurred by a firm may be classed into two groups: fixed costs and variable costs.
  • Variable costs change with the level of output, increasing as more product is generated.
  • Fixed cost and variable cost, combined, equal total cost.
  • The above method takes the perspective of total revenue and total cost.
  • A firm may also take the perspective of marginal revenue and marginal cost, which is based on the fact that total profit reaches its maximum point where marginal revenue equals marginal cost.

• Cost-Based Pricing

  • Cost-based pricing is the act of pricing based on what it costs a company to make a product.
  • Cost-based pricing is the act of pricing based on what it costs a company to make a product.
  • Price = (1+ Percent Markup)(Unit Variable Cost + Average FixedCost) .
  • A company must know its costs.
  • Cost-based pricing is misplaced in industries where there are high fixed costs and near-zero marginal costs.

• Markup Pricing

  • Basically, this approach sets prices that cover the cost of production and provide enough profit margin to the firm to earn its target rate of return.
  • Information on demand and costs is not easily available; however, this information is necessary to generate accurate estimates of marginal costs and revenues.
  • So the relevant cost would be the cost that a buying company would incur if it made the product itself.
  • The total cost has two components: total variable cost and total fixed cost.
  • A cost-plus price will equal average variable costs plus average fixed costs plus markup per unit.

• New Product Pricing

  • In the introductory stage of a new product's life cycle means accepting a lower profit margin and to price relatively low.
  • It creates cost control and cost reduction pressures from the start, leading to greater efficiency.
  • It can be based on marginal cost pricing, which is economically efficient.
  • Skimming is usually employed to reimburse the cost of investment of the original research into the product.
  • In this case, "Premium" does not just denote high cost of production and materials- it also suggests that the product may be rare or that the demand is unusually high.

• Break-Even Analysis

  • Try to reduce the fixed costs (by renegotiating rent for example, or keeping better control of telephone bills or other costs)
  • In the linear Cost-Volume-Profit Analysis model, the break-even point - in terms of Unit Sales (X) - can be directly computed in terms of Total Revenue (TR) and Total Costs (TC) as: where TFC is Total Fixed Costs, P is Unit Sale Price, and V is Unit Variable Cost.
  • The quantity (P - V) is of interest in its own right, and is called the Unit Contribution Margin (C).
  • It is the marginal profit per unit, or alternatively the portion of each sale that contributes to Fixed Costs.
  • It assumes that fixed costs (FC) are constant.

• Other Pricing Strategies

  • The business owner can cut costs, sell more, or find more profit with a better pricing strategy.
  • Cost-plus pricing is the simplest pricing method.
  • The firm calculates the cost of producing the product and adds on a percentage (profit) to that price to give the selling price.
  • The limit price is often lower than the average cost of production or just low enough to make entering not profitable.
  • The goal of such a policy is to realize a large sales volume through a lower price and profit margins.

• Changes in Pricing

  • In the global marketing mix, pricing factors are manufacturing cost, market place, competition, market condition, and quality of product.
  • High prices will also be needed to cover high costs of manufacturing, or extensive advertising and promotional campaigns.
  • If manufacturing costs go up due to the rise in price of some raw material, then prices will need to rise as well.
  • Pricing can also be affected by the cost of production (locally or internationally), natural resources (product ingredients or components), and the cost of delivery (e.g., the availability of fuel).
  • Additionally, the product's positioning in relation to the local competition influences the brand's ultimate profit margin.