Marginal cost is another economic cost category. Marginal costs are the incremental costs needed to change the status of an item.
This is the exact opposite of sunk costs, which are costs that have already been spent and cannot be canceled. For example, a company has rented a warehouse. The cost to rent the warehouse is a sunk cost if it cannot be canceled.
The company is considering manufacturing sports equipment for the duration of the lease. The marginal cost would be the additional costs needed to create the sports equipment. This categorization can help decision making.
For example, the total cost of the lease was $10,000. The marginal cost to manufacture sports equipment for the duration of the lease is $5,000. The sports equipment is expected to generate $12,000 in revenue.
If the company only has two options, manufacture sports equipment, or leave the warehouse empty, the best course of action is to manufacture. This is the best action since the marginal revenue exceeds the marginal cost. For analysis purposes, the sunk costs are irrelevant. Here is a detail of the calculations showing this:
- Empty Warehouse: -10,000, with no revenue. Total loss of $10,000
- Manufacture: -10,000 – 5,000 + 12,000 = -3,000. Total loss of $3,000