Incremental Cost

Incremental Cost is defined as the cost associated with increasing production by one unit. It is also known as the marginal cost. It refers to the encompassing change that a company experiences within its balance sheet due to one additional unit of production. The marginal cost of a company varies according to how many more or fewer units a company wishes to produce. There may be an increase or decrease the marginal cost according to the increase in production. This is because the marginal cost includes all costs such as labor, materials, and the cost of infrastructure. The cost figure is used for a variety of economic calculations.

Let us take an example. If a manufacturer of widgets increases the number it produces, it may need to buy more material, but the costs of labor and factory maintenance remain the same, and are spread out over a greater number of widgets. This may reduce the marginal cost. On the other hand, if a manufacturer hires more workers and builds another factory, it will likely increase the marginal cost. It is also known as the incremental cost.

The incremental cost total is always composed of purely variable costs. It represents that the added costs would not exist if the additional unit was not made. The fixed costs, for example the rent on a factory or buying a machine are not usually represented. Generally the average cost of a unit will be higher than the incremental cost. The average fixed costs include the fixed costs. Consider an example. Assuming that a company spends a set sum on machines each year, this cost will be represented in the average cost of each unit produced on those machines. In this case the cost will not be included in the incremental cost as producing one extra unit does not require any more spending on buying machines.

Questions

•  What is incremental cost?
• What is the incremental cost composed of? Explain with an example.