Incremental Costs
Incremental costs are associated with a choice and therefore only ever include forward-looking
costs. Previously made purchases or investments, such as the cost to build a factory, are called
“sunk” costs and are not included. The Incremental cost can include many different direct and
indirect cost inputs depending upon the situation. However, only costs that will change as a
result of the decision are to be included. When a factory production line is at full capacity, the
incremental cost of adding another production line might include cost of the equipment, the
people to staff the line, electricity to run the line and additional human resources and benefits.
Understanding Incremental Cost
According to "The Free Dictionary," incremental cost is the cost of adding or subtracting one
extra unit of product or output. For example, a restaurant is only allowed to seat 100 people, per
the fire department regulations. The restaurant is doing well, and wants to seat 101 people or
more. The owners will have to build an addition with extra fire escape doors. The restaurant will
have to incur thousands of dollars of building costs for the addition, just to seat one extra person.
Marginal Costs
Marginal cost is a more specific term, referring to the cost to produce one more unit of product
or service. Originally used to optimize production, products with high marginal costs tend to be
unique, labor intensive or at the beginning of a product life cycle. Low marginal cost items are
often very price competitive. The classic example is the cost to print encyclopedias. It costs a lot
to print the first encyclopedia. Research must be done, entries written, copy typeset. But it
requires very little additional cost to print the 10,000th encyclopedia. Marginal cost may equal
incremental cost when only one additional unit is being considered.
Understanding Marginal Cost
A marginal cost is slightly different from an incremental cost. According to the National
Productivity Council of India, or NPCI, marginal cost is the original cost plus the extra cost of
producing an extra unit of output, resulting in a total cost. In the restaurant example, the original
pre-existing building costs are added in to the new cost of building the addition, resulting in a
total cost.
A typical marginal cost curve with marginal revenue overlaid. Price is on the vertical axis and
quantity on the horizontal axis.
In economics, marginal cost is the change in the opportunity cost that arises when the quantity
produced is incremented by one unit, that is, it is the cost of producing one more unit of a good.
[1] Intuitively, marginal cost at each level of production includes the cost of any additional
inputs required to produce the next unit. At each level of production and time period being
