Cost, Marginal

Marginal cost is the cost of producing an additional unit of output. For example, supposing a supplier produces 100 units at a cost of $1000, and the cost of making 101 units is $1005. The average cost per unit is $10, but the marginal cost of the 101st unit is only $5. When negotiating with suppliers, buyers may seek to persuade the supplier to set a price that covers their marginal costs only, rather than adopt absorption costing. Absorption costing means that the product absorbs all of the variable costs and overheads. In the example above, a marginal costing argument might be used to suggest a price of $6 per unit, covering the supplier’s variable costs and making a contribution towards overheads and profit. See also Total Absorption Costing.