Marginal Costing is a type of flexible standard costing thatseparates fixed costs from proportional costs in relation to theoutput quantity

of the objects. In particular, Marginal Costing is acomprehensive and sophisticated method of planning andmonitoring costs based on resource drivers. Selecting the resourcedrivers and separating the costs into fixed and proportionalcomponents ensures that cost fluctuations caused by changes inoperating levels, as defined by marginal analysis, are accuratelypredicted as changes in authorized costs and incorporated intovariance analysis. This form of internal management accounting has become widelyaccepted in business practice over the last 50 years. During thistime, however, the demands placed on costing systems by costmanagement requirements have changed radically. MARGINAL COST Ineconomicsandfinance, marginal cost is the change intotal cost that arises when the quantity produced changes by one unit. It isthe cost of producing one more unit of a good. [1] Mathematically, themarginal cost (MC) function is expressed as the firstderivativeof thetotal cost(TC) function with respect to quantity (Q). Note thatthe marginal cost may change with volume, and so at each level of production, the marginal cost is the cost of the next unit produced.A typical Marginal Cost Curve

In general terms, marginal cost at each level of production includesany additional costs required to produce the next unit. If producingadditional vehicles requires, for example, building a new factory, themarginal cost of those extra vehicles includes the cost of the newfactory. In practice, the analysis is segregated into short and long-run cases, and over the longest run, all costs are marginal. At eachlevel of production and time period being considered, marginal costsinclude all costs which vary with the level of production, and othercosts are considered fixed costs.A number of other factors can affect marginal cost and itsapplicability to real world problems. Some of these may beconsidered market failures. These may includeinformationasymmetries, the presence of negative or

positiveexternalities,transaction costs,price discriminationand others. RELATION BETWEEN MARGINAL COST AND ECONOMIES OFSCALE Production may be subject toeconomies of scale(ordiseconomies of scale).Increasing returns to scaleare said toexist if additional units can be produced for less than theprevious unit, that is, average cost is falling. This can only occur if average cost at any given level of production is higher than the marginal cost. Conversely, there may be levels of production where marginalcost is higher than average cost, and average cost will rise foreachunit of productionafter that point. This type of production function is generally known as diminishingmarginal productivity: at low levels of production,productivity gains are easy and marginal costs falling, but productivitygains become smaller as production increases; eventually,marginal costs rise because increasing output (with existingcapital, labour or organization) becomes more expensive. Forthis generic case, minimum average cost occurs at the pointwhere average cost and marginal cost are equal (whenplotted, the two curves intersect); this point will not be at theminimum for marginal cost if fixed costs are greater than zero. Short and long run marginal costs and economies of scale The former takes as unchanged, for example, the capital equipmentand overhead of the producer, any change in its productioninvolving only changes in the inputs of labour, materials and energy.

The latter allows all inputs, including capital items (plant,equipment, buildings) to vary.A long-run cost function describes the cost of production as afunction of output assuming that all inputs are obtained at currentprices, that current technology is employed, and everything is beingbuilt new from scratch. In view of the durability of many capitalitems this textbook concept is less useful than one which allows forsome scrapping of existing capital items or the acquisition of newcapital items to be used with the existing stock of capital itemsacquired in the past. Long-run marginal cost then means theadditional cost or the cost saving

per unit of additional or reducedproduction, including the expenditure on additional capital goods orany saving from disposing of existing capital goods. Note thatmarginal cost upwards and marginal cost downwards may differ, incontrast with marginal cost according to the less useful textbookconcept.Economies of scale are said to exist when marginal cost accordingto the textbook concept falls as a function of output and is less thantheaverage costper unit. This means that the average cost of production from a larger new builtfrom-scratch installation fallsbelow that from a smaller new builtfrom-scratch installation. Underthe more useful concept, with an existing capital stock, it isnecessary to distinguish those costs which vary with output fromaccounting costs which will also include the interest anddepreciation on that existing capital stock, which may be of adifferent type from what can currently be acquired in past years atpast prices. The concept of economies of scale then does not apply. Externalities Externalities are costs (or benefits) that are not borne by the partiesto the economictransaction. A producer may, for example,pollute the environment, and others may bear those costs. A consumer mayconsume a good which produces benefits for society, such aseducation; because the individual does not receive all of thebenefits, he may consume less than efficiency would suggest.Alternatively, an individual may be a smoker or alcoholic andimpose costs on others. In these cases, production or consumptionof the good in question may differ from the optimum level.

Marginal Costing

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