What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


When Is the Marginal Cost Horizontal?

Original post by Ben Taylor of Demand Media

Marginal cost is horizontal when its value is constant for every unit produced.

Marginal cost measures the cost a company incurs when producing one more unit of a good. To calculate marginal cost, subtract the total cost of producing one unit from the total cost of producing two units. The difference is marginal cost for two units. For example, if producing two clocks costs $4 and producing one costs $3.50, the company's marginal cost for producing two clocks is $0.50. When charted linearly, a marginal cost trends horizontally when marginal costs are constant. A company's marginal cost curve is horizontal when its marginal cost does not change no matter how many units of a product it produces.

Contents

When Equal to Unit Price

In a perfectly competitive market, firms maximize profits by producing goods at a volume in which marginal cost equals unit price, according to the website AmosWEB. If the unit price of a good is stable -- or if it is approaching stability -- no matter the production volume, marginal cost will trend in the same manner. If marginal cost is equal to price, then the value of goods produced is equal to that of goods not produced, according to AmosWEB.

When Production is Optimized

Marginal revenue is the added revenue of selling one additional unit. If a firm optimizes its level of production, both marginal revenue and marginal cost will be horizontal when charted linearly. A firm can maximize its profits by producing goods at a volume in which marginal cost is equal to marginal revenue, according to the Money Terms website. To optimize production, a firm must gauge how much of its resources are used to produce a good, as well as how closely its production correlates with the product's demand.

Equal to Average Cost

If the average cost of producing a good is constant, a firm's marginal cost can also be constant if it is equal to average cost, both of which would be represented horizontally on a linear graph. Consider a constant-cost industry, for example. In such an industry, the long-run industry supply curve is horizontal because expansion of the market causes no change in production or resource costs, according to AmosWEB. Marginal costs are constant when production costs are constant.

Relationship to Supply

A firm's marginal cost curve also acts as its supply curve; because of this relationship, factors that cause a firm's supply of a good to fluctuate affect the stability of marginal cost, according to the Fundamental Finance website. For a company that produces energy with coal, for example, a surplus or shortage of coal -- the firm's supply -- will change the cost of producing one more unit of energy. A surplus of coal will decrease marginal cost and a shortage of coal will increase marginal cost.


                   

Resources

References

About the Author

Ben Taylor has been writing since 2005 and has had work published by WEKU-FM and West Virginia Public Broadcasting both on air and online. Taylor holds a Master of Arts in English from Eastern Kentucky University and currently teaches composition and ESL there.

Photo Credits

  • Jupiterimages/Photos.com/Getty Images


Advertisement