What Is Constant Marginal Cost?
Constant marginal cost is the total amount of cost it takes a business to produce a single unit of production, if that cost never changes. Since the cost is the same for every single unit produced, it is considered a constant. The variable part of the equation to estimate costs is the total volume of items that the company produces. As that amount changes, so too will the costs for the production order, even as the constant marginal cost remains unchanged.
Companies that produce items in mass quantities must always be cognizant of the costs associated with production. Doing so requires coming up with methods for estimating these costs before production orders are filled. By performing these estimates, management can properly budget for any size order it may receive, all while making sure that the company's bottom line improves. It is important to understand the concept of constant marginal cost in order for companies to set up production systems that allow them to produce goods at a steady cost rate no matter the size of the order.
Trying to understand this concept can be tricky, since the name implies two seemingly opposite things working against each other. The marginal cost is the cost it takes to produce a single item. If that cost is constant, it means that one item will cost exactly the same whether it is the first item being produced for an order or the millionth. For example, if it takes $100 US Dollars (USD) for a company to make a single item, and that remains unchanged for an entire order, the constant marginal cost is $100 USD.
It is also important to separate this cost from fixed costs. Fixed costs are those costs attached to production no matter what the scenario might be. For example, simply turning the lights on in a factory costs the parent company a certain amount of money. Those costs will be incurred every time production is underway. The constant marginal cost, even as it remains the same, will be multiplied to the amount of items produced to yield the variable costs, which, unlike fixed costs, change depending on the size of the order.
When estimating costs for production, the constant marginal cost is often part of a linear cost function. Total costs will be equal to fixed costs added to variable costs, which, as mentioned above, is dependent on the marginal cost. Such a function is linear because the marginal cost is constant, causing the values for the number of items produced and total costs, when shown on a graph, to form a straight line. This does not occur when the marginal cost varies depending upon the amount of items being produced.
What Is the Formula for Constant Marginal Cost?
Normal Marginal Cost Formula
Normally, the formula for calculating marginal cost involves dividing total production cost changes by the increase in the number of units produced. In other words, you need to calculate new costs minus current costs and divide the total by new unit quantity minus current unit quantity.
Imagine that a manufacturer wants to see how much it would cost to double production from 10,000 units to 25,000 units. Currently, it costs $200,000 to produce the 10,000 units. Producing 25,000 units would raise costs to $350,000. To calculate marginal cost, follow this formula:
- Marginal cost = ($350,000 - $200,000) / (25,000 – 10,000)
- This is the same as $150,000 / 15,000 = $10
- The marginal cost would be $10 per unit for the increased production
Constant Marginal Cost Formula
Constant marginal cost means that the increased cost of production is the same for every unit. The scale is horizontal. In that case, finding the total cost is simply a matter of finding the marginal cost increase for two units and multiplying by the total number for production.
For example, if it costs $10 to produce one unit, and $15 to produce two, then the marginal cost is $5 for two units. For three units, the marginal cost would be $10. This trend would continue indefinitely because the cost of production per unit remains the same. Here’s what the formula would look like for calculating total production costs:
- Total production cost = marginal cost per additional unit x total additional units
- This is the same as c x t = p
- For 10,000 additional units, the calculation would be $5 x 10,000 = $50,000
What Does It Mean When Marginal Cost Curves Slope Upward, Downward and Horizontally?
Ideally, businesses want their marginal cost curve to slope downward or horizontally. A downward slope means that the cost per unit of production gets lower with every unit manufactured. It’s in the company’s interest to increase production levels and maximize profits. This situation can arise when manufacturers can negotiate discounts or snap up raw materials during a large drop in pricing.
Once trends skew horizontally, a balance point has been reached. This point is where the company has achieved its ideal production level, balancing marginal cost with marginal revenue. The cost of creating additional units is equal to the additional revenue generated from sales.
Upward trends for marginal costs indicate that the business may need to scale back on production. The cost per unit at current levels is greater than the revenue obtained from manufacturing additional items. This can happen when raw materials used for production, or labor costs for additional employees, rise sharply.
What Is an Example of a Constant Marginal Cost?
Businesses can achieve a constant marginal cost when the required elements for production are at fixed or relatively stable values. Generally, it takes time to reach this level, which is why many manufacturers try to ramp up production capabilities as quickly as possible. Larger production output can help businesses reach better pricing tiers and have more stable costs for raw materials.
A large-scale bottling company that purchases plastic bottles, product labels, syrup and flavorings in bulk may be able to maintain constant marginal costs for some time. Until the supply of bottles and other ingredients runs out, there is virtually no change in the cost per unit of production. Changes in plastic prices, materials and energy costs can alter this balance, however.
Other businesses that can achieve constant marginal costs depend primarily on labor instead of raw materials for increasing revenue. Technology companies designing software have costs related to employee numbers, but the price to produce two units of software versus three or more units is often fairly constant.
This concept seems highly subjective to external forces. The cost is supposed to be constant, but what happens if, say, the cost of raw materials increases? The term "constant" might not be applicable, after all.
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