What Is Marginal Cost Pricing & How to Calculate It

In our previous guides, we reviewed pricing strategies that rely on a large multitude of external factors: demand, buyer’s purchasing power, seasonality, and so on. But not all pricing approaches depend on market conditions – some businesses calculate the cost of their goods based on expenses involved. Marginal cost pricing is one of such approaches: it takes into account the cost of manufacturing a product. This article explains how it differs from cost-plus strategy, how to calculate margin cost pricing, and when it can be applied successfully.

Marginal cost is the additional cost a business incurs when producing one more unit of a product. In other words, it’s the change in total cost divided by the change in quantity of output. This number helps companies decide whether it’s profitable to increase production or not.

In a perfectly efficient scenario, marginal cost equals marginal revenue—meaning every extra unit sold adds value without cutting into profits. But in reality, rising marginal cost can signal diminishing economies of scale. Understanding how the marginal cost curve behaves is essential for pricing, planning, and production efficiency.

If you're searching for a fast marginal cost definition, this is it: the cost of making one more unit. And it plays a critical role in any marginal cost analysis, especially when setting prices that protect your revenue and scale your business operations wisely.

In economics, the practice of setting a product's price to cover the variable expense resulting from producing an additional unit is known as marginal cost pricing. This pricing policy presupposes charging only the addition to the total cost of labor and materials. When sales are low, businesses frequently set prices near to the marginal costs. For example, a company used to charge $3 for a cup of coffee. When demand declined, it lowered the price to $1.25 to cover $1 of raw materials and barista’s labor: it resulted in $0.25 of pure profit. The reason the coffeeshop would pick this strategy is because a 25 cent profit from the transaction is better than no sale at all.

At first glance, marginal cost pricing seems to be unprofitable at all, however, this strategy has certain benefits for businesses if applied in the correct cases, which we will describe later. But first, let’s find out how marginal cost pricing is formed.

In economics, marginal cost refers to the cost of producing one additional unit of a product. It’s a foundational concept used in marginal cost analysis to determine optimal pricing, output, and production efficiency. The marginal cost definition is expressed as the change in total cost divided by the change in quantity of output.

Mathematically, this is shown as:

Marginal Cost (MC) = Δ Total Cost / Δ Quantity Produced

The marginal cost curve typically slopes downward at first due to economies of scale, then rises as marginal cost increases when capacity limits are reached. This reflects the law of diminishing returns—where adding more inputs results in a smaller increase in output.

Marginal cost economics is crucial for firms aiming to match marginal revenue with marginal cost to maximize profit. It's also a key tool for setting the cost of production in fast-moving or volume-sensitive industries.

Before providing an example of marginal-cost price calculation, we should outline three important concepts.

First, Fixed costs. Thisis a particular type of expense the value of which does not alter when production volume changes. The price of a manufacturing machine is a good case in point. The company incurs the same fixed expenses while raising output.

Second, Variable costs. They alter as production volume changes: grow when it increases, and go down when production declines. Most often, variable expenses include raw materials.

Marginal cost is the third category. When a company manufactures one extra unit of a product, it involves an additional cost.

The formula is as follows:

Now, let’s observe a simple example.
A manufacturer produces 20 units with variable cost of $10 per unit and fixed costs of $100. To sell 20 units of output, the manufacturer implements a cost-plus pricing strategy and decides on a profit margin of 5% of the cost. In this case, the selling price per unit is $15.75 = $15 + ($15*0.05).

However, if the manufacturer implements a marginal cost pricing strategy, it may charge $5 per unit. It seems to be unprofitable, doesn’t it? Not always – let’s observe the situations when marginal cost pricing strategy is typically applied.

Let’s break down a basic marginal cost example to make the formula easy to understand.

Suppose a company produces 100 units of a product at a total cost of $1,000. After producing one additional unit (101 units total), the new total cost rises to $1,015. To find the marginal cost of producing that extra unit, we apply the marginal cost formula:

MC = (Change in Total Cost) / (Change in Quantity)
MC = ($1,015 − $1,000) / (101 − 100) = $15

This means the marginal cost of that 101st unit is $15. If the marginal revenue from selling that product is higher than $15, it makes sense to continue production. But if marginal cost rises beyond additional revenue, the firm might lose money per unit.

Understanding this marginal cost calculation helps improve production efficiency, maximize revenue, and plan pricing aligned with the actual cost of production.

To fully understand marginal cost analysis, it's important to know the difference between fixed costs and variable costs—two core components of cost classification in economics.

Fixed costs are expenses that stay the same regardless of how many units a business produces. These include things like rent, salaried labor, and equipment. Whether you produce 10 or 10,000 units, these costs don’t change. They are not part of marginal cost calculation.

In contrast, variable costs fluctuate with production volume. This includes materials, packaging, and hourly labor—costs that rise with each additional product. When calculating marginal cost, we focus only on how these costs increase as quantity of output increases.

For example, if it costs $100 to produce 10 units and $110 to produce 11, the marginal cost of producing the 11th unit is $10. This doesn’t include your fixed costs—only the additional variable cost of production.

Understanding the balance between fixed and variable costs supports better pricing, budgeting, and production efficiency, especially when using tools for marginal cost analysis and managing economies of scale in your business.

Knowing how to calculate marginal cost is key for managing pricing and production efficiency. Here’s a simple step-by-step approach for any business looking to optimize operations and increase revenue.

Step 1: Determine your total cost of production before and after increasing output. Include only relevant variable costs, not fixed overhead.

Step 2: Calculate the change in total cost. Subtract the total cost at the lower quantity from the total cost at the higher quantity.

Step 3: Calculate the change in quantity produced. This is usually just one unit for most marginal cost analysis.

Step 4: Divide the cost change by the quantity change.

Marginal Cost = Change in Total Cost / Change in Quantity

These calculation steps are critical in forecasting pricing behavior, evaluating marginal revenue, and understanding your marginal cost curve. Whether you're expanding production or testing new pricing, mastering this formula helps pinpoint your optimal cost at every output level—giving you data-driven control over product pricing and profitability.

Let’s explore a marginal cost case study using a simplified scenario from a mid-sized manufacturing business that produces eco-friendly water bottles.

The company currently produces 100 units at a total cost of $5,000. To scale up, they increase output to 101 units, raising the total cost of production to $5,075. This means the change in total cost is $75, and the change in quantity produced is 1.

Using the marginal cost formula:

Marginal Cost = Change in Total Cost / Change in Quantity
MC = $75 / 1 = $75

This marginal cost of producing the 101st unit gives the pricing team critical insight. If the unit's marginal revenue is below $75, the cost curve may be too steep—signaling it's time to revisit production efficiency or supplier contracts. If it's above, the additional revenue supports further growth.

This real company example highlights the strategic role of marginal cost calculation in price setting, scaling, and improving economies of scale.

Marginal cost pricing is particularly effective when a business aims to boost short-term revenue or maximize production efficiency without drastically altering its core pricing strategy. One ideal situation is when a company has excess capacity and the marginal cost of producing an additional unit is low. Selling additional units just above the marginal cost can generate extra revenue without significantly increasing total costs.

This pricing approach also works well during promotional campaigns or when entering a highly competitive market. Businesses can attract price-sensitive consumers by offering a lower price while still covering the marginal cost of producing the goods. It’s also suitable in industries where economies of scale play a critical role in cost reduction.

Additionally, marginal cost pricing is helpful when marginal cost equals marginal revenue, ensuring that each unit sold contributes positively to profit. However, it’s not ideal for long-term strategies where recovering fixed costs and maintaining healthy margins is critical for sustainability.

While marginal cost pricing can drive short-term sales and improve production efficiency, businesses must evaluate the broader strategic context before adopting it as a primary pricing strategy. One key consideration is market competitiveness. In saturated markets, offering prices close to marginal cost might spark a price war, reducing profitability for everyone involved.

Companies should also assess the long-term impact on revenue and brand perception. Continuously setting low prices can erode consumer trust in product value and make it difficult to increase prices later without backlash. Additionally, relying solely on marginal revenue to guide decisions may overlook essential fixed costs and weaken sustainability.

Strategic pricing considerations should also include timing, demand elasticity, and economies of scale. For example, using marginal cost pricing temporarily to offload excess inventory might be effective, but it should be supported by a clear plan for returning to profitable price levels.

In summary, marginal cost pricing is a valuable tool in the pricing arsenal—but like any tactic, it should serve a well-defined business goal and align with long-term cost and marginal performance metrics.

Understanding the difference between marginal and average cost is crucial for making smart business decisions. While both relate to cost of production, they serve distinct roles in pricing and operational analysis.

Marginal cost refers to the increase in total cost from producing one additional unit. It's calculated using the formula:
Marginal Cost (MC) = Change in Total Cost / Change in Quantity Produced
This value reflects the cost of expanding output and is vital in determining whether scaling production boosts or reduces profitability.

In contrast, average cost (or unit cost) is the total cost divided by the number of units produced. The formula is:
Average Cost (AC) = Total Cost / Quantity Produced
This gives the per-unit cost across all output levels and helps assess overall production efficiency.

A key difference lies in how they interact with fixed costs and variable costs. Average cost includes both, while marginal cost is influenced only by variable costs, assuming fixed costs stay constant. That’s why as output increases, average cost tends to decline (due to economies of scale) until variable costs begin rising sharply.

For example, if your business is deciding whether to produce more units of a product, marginal cost analysis can help determine if the additional revenue will exceed the marginal cost of producing. If marginal cost is lower than average cost, it’s usually beneficial to expand output.

From a pricing strategy perspective, marginal cost equals the floor price in competitive markets. When setting the ideal price, combining marginal cost calculation with marginal revenue forecasting provides a sharper view of profit potential and how to respond to cost changes efficiently.

Ultimately, mastering both marginal cost and average cost helps you build a smarter cost curve, price your products more effectively, and maintain production efficiency over time.

Knowing when to use marginal cost versus average cost depends on the type of decision your business is making. If you're evaluating whether to produce one more unit of a product, use marginal cost analysis. It tells you if the additional revenue from selling that unit will cover the marginal cost of producing it. This is especially useful in short-term pricing, promotions, or scaling scenarios.

In contrast, average cost works better for long-term financial planning and cost of production analysis. If you're setting baseline prices, estimating profitability across total output, or benchmarking production efficiency, average cost gives the full picture, including fixed costs.

For instance, a manufacturer launching a new product may use average cost to assess overall viability, but once production ramps up, they’ll track marginal cost to fine-tune output decisions. Understanding the cost curve and applying each concept at the right time can boost profitability and support smarter pricing.

Yes, businesses cannot always employ this pricing strategy, but it proves to be efficient in the following situations:

• The business has achieved the break-even point. When it happens, the expense of manufacturing has been totally covered by revenue. Hence, all the extra units produced may be sold at their marginal cost without hurting profit and economical viability.
• The amount of additional production the company can produce is still larger than the volume needed to break even.
• The business implements an aggressive pricing approach, such as a loss leader.

Let’s observe price formation when the company reaches the break-even volume. We can deploy the following formula:

Break-even volume = Fixed cost / (Selling price per unit – Variable cost per unit) = $100 / ($ 15.75 – $10) = 18 units (rounded up).

With an output of 18 pieces, the manufacturer has fixed costs of $100. Meanwhile, its variable costs are $180 = 18 pcs x $10. Thus, the total cost is $280 at that volume.

The revenue from selling 18 items is $283.5 (18 pcs x $ 15.75).

With its current capacity, the company can still increase its output to 24 pieces. For the next 6 outputs, it can apply marginal cost pricing.

Let’s calculate the marginal cost resulting from raising output from 18 units to 24 units.

Total fixed costs stay the same ($100). With the average variable cost of $10, the total variable cost is $240. So the total cost of producing 24 units is $340 ($100 + $ 240).

Marginal cost = ($340 – $280) / (24 – 18) = $10

The initial 18 units of production are priced at cost plus. The business charges a selling price of $15.75 per unit with a markup of 5% over average cost. At that rate, the business made $283.5 in profit and can cover its $280 manufacturing expenses.

For the following six units, marginal cost pricing is set at $10 per unit. The business generates $60 in sales at that pricing.

You can see that the company will record total revenue of $343.5 ($283.5 + $60) if it sets the selling price of the additional output at its marginal cost. It barely generates any profit, but companies use such pricing approach if their primary goal is to increase market share.

If the company's primary objective is to make a profit, it may set the selling price for the additional 6 units of output at the break-even point average cost ($15). In this case, extra manufacturing generates $90 for the company (6 pcs x $15). The company would make total sales of $373.5, which is more than its entire cost of producing 24 pieces of product ($340).

Marginal cost pricing is used due to the following facts:

• The computations are not sophisticated – you can figure out marginal cost using simple formulas.
• It allows attracting highly price-sensitive customers and making some extra money from these clients.
• This pricing strategy can be useful if a company has surplus manufacturing capacity. The business may boost production and sell it for less than it would normally cost.

Before trying marginal cost pricing in your business, consider its drawbacks:

• This strategy may not work out in the long term unless the business has all its manufacturing expenses fully covered.
• Customers anticipate that the business will keep its prices low even further. Therefore, increasing rates in the future will be more difficult.
• Buyers may resell products bought for marginal cost and make profit. The manufacturer risks losing a part of customers and its revenue.

Short-run marginal cost refers to the additional cost of producing one more unit of a product when at least one input—typically capital—is fixed. This differs from general marginal cost, which may assume all inputs are variable, especially in long-run analysis. In short-run scenarios, fixed costs such as rent or salaried labor remain constant, meaning any change in total cost is driven solely by variable costs.

This distinction becomes crucial for business decisions involving temporary capacity limits or sudden increases in demand. The cost curve in the short run often shows a steep rise after a certain quantity of output, reflecting diminishing production efficiency due to constraints on equipment or space.

Understanding this difference helps firms make better short-term pricing decisions, especially in sectors where flexibility is limited. For example, during peak seasons, rising short-run marginal cost can justify raising prices to protect revenue margins without sacrificing long-term competitiveness.

By including short-run marginal cost in your overall marginal cost analysis, you gain more precise insights into profitability across time frames and better align pricing with operational realities.

Long-term marginal cost is shaped by a range of structural and operational factors that evolve over time. One of the most significant is economies of scale—as production volume increases, the cost of production per unit can decline due to more efficient resource use, better supplier deals, and automation. This trend flattens the marginal cost curve, supporting sustained growth in revenue without proportionate cost increases.

Technological innovation also plays a critical role. Investments in improved machinery, software, or logistics systems can dramatically boost production efficiency, thereby lowering the marginal cost of producing additional units. On the flip side, outdated technology or capacity bottlenecks can lead to a rising marginal cost over time.

Market conditions—like shifts in consumer demand or regulatory pressures—may also impact long-term marginal cost, especially in industries with volatile inputs or compliance-related expenses. Businesses that actively monitor these cost factors and adjust accordingly can gain a significant pricing edge and preserve profitability at scale.

Understanding these variables is key for accurate marginal cost analysis and building a forward-looking pricing strategy that aligns with long-term goals.

Marginal cost pricing focuses on setting prices based on the additional cost incurred when producing one more unit of a product. Even an eMarketer survey states that price optimization is the thing which is directly tied to a company's revenues. For businesses trying to optimize profitability while maintaining competitive prices, Priceva's tools can play a vital role in supporting effective marginal cost pricing strategies. With Priceva's price monitoring, businesses can continuously track market prices and competitor movements. This real-time data allows companies to adjust their pricing to align with market trends while ensuring that their marginal costs are covered and profit margins remain sustainable. By using market insights, you can find the perfect balance between covering variable costs and offering competitive prices.

Accurate marginal cost calculation is critical for data-driven decision-making. Businesses can streamline this process using specialized pricing software or an online marginal cost calculator. These tools automate complex calculations and reduce the risk of human error when analyzing changes in total cost and output.

Platforms like Excel offer manual templates, but advanced SaaS tools (like Priceva) provide more robust options for real-time marginal cost analysis, integrating marginal revenue, quantity produced, and cost of production into dynamic dashboards. Some calculators even visualize your cost curve or help you evaluate economies of scale for long-term forecasting.

Using the right software improves production efficiency and ensures that business decisions are based on reliable marginal cost formulas. Whether you're a small company seeking additional revenue or a manufacturer managing thousands of units, automation helps maintain accuracy and profitability.

Effective cost tracking is essential for accurate marginal cost calculation and long-term business success. To support a strategic marginal pricing model, businesses should implement clear, consistent cost accounting practices. This starts with distinguishing between fixed and variable costs, then logging every cost of production component as it occurs.

Use dedicated accounting software to monitor changes in total cost and automate the aggregation of expenses across raw materials, labor, and overhead. These systems simplify marginal cost analysis by producing real-time updates on quantity of output and cost per unit, helping managers track how cost fluctuates with production efficiency.

Aligning this data with marginal revenue insights gives companies an edge in forecasting additional revenue opportunities and identifying when marginal cost rises due to scale limits. Ultimately, solid cost tracking enables better pricing decisions, more control over revenue, and a deeper understanding of your marginal cost curve.

Although it seems to be unprofitable, margin cost pricing approach can be useful when it is applied properly. If you can allow manufacturing extra goods or delivering extra services without changing fixed costs and incurring large expenses, margin pricing allows attracting price-sensitive buyers and selling more products. Besides, you can use this strategy to penetrate the market and increase sales of accessories and related goods.

If you don’t know whether keeping prices close to marginal cost is a good idea for your business, implement the repricing tool by Priceva: it will help you optimize rates so as to meet your profit goals. No manual analysis – the software will calculate the best price based on pre-set formulas and, if necessary, update it right in your online store.

Marginal cost is important because it helps businesses make informed decisions about production levels and pricing. It represents the cost of producing one additional unit of a product or service. By comparing marginal costs with revenues, businesses can determine the optimal quantity to produce and the appropriate price to charge, maximizing their profitability. Understanding marginal cost also allows companies to identify potential inefficiencies and cost-saving opportunities within their production processes.

The average cost of items is the total cost of goods divided by their total number. Marginal cost is calculated differently: it increases when an extra unit of product or service is delivered. Marginal cost fluctuates when the total cost of production changes because of a different quantity of production.

Marginal cost does not equal price, because the latter can be formed under a multitude of factors, and sellers take into account other variables, not just margin. However, marginal cost can equal price sometimes. For example, in situations of perfect competition, it becomes possible – this is the equilibrium condition where the companies maximize their profits. At this point, price equals marginal cost and average total cost of producing one good. If a company charges a price above the marginal threshold, it may lose its market share.

Total cost refers to the entire cost of producing a certain quantity of goods, including both fixed and variable expenses. Marginal cost, by contrast, is the cost of producing one additional unit of output. While total cost grows with quantity, marginal cost helps determine how much each new unit adds to that total.

Technically, marginal cost cannot exceed total cost, since it is only a portion of it. However, if marginal cost increases sharply while output remains low, it may signal production inefficiencies or diseconomies of scale, making further production unprofitable.

Marginal cost can be zero in rare cases where producing an extra unit incurs no additional expense—usually when fixed resources aren't yet maxed out. Negative marginal cost is not realistic in practice, as it would imply the company saves money by producing more, which contradicts basic economic principles.

A marginal cost curve typically forms a U-shape. It shows that costs initially fall due to increased efficiency, then rise as capacity limits and variable costs grow. Analyzing this curve helps businesses identify the optimal level of output before costs begin to outweigh potential revenue gains.