CFA CFA Level 1 Not able to get my head around Marginal cost.

Not able to get my head around Marginal cost.

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      I understand the principle of diminishing marginal product, wherein as the number of workers increase the marginal/additional production in quantity of the product they bring will start to decrease and Marginal cost principle is based on that.

      So, let’s say:



      1———-40——100———–80 ——–180———-$2


      3———120 —–100———-240——-340——–$2.67


      Now, when the 1 worker is appointed, he produces 40 units of additional product and to produce these 40 units, it costs an additional $2 per unit.
      Which mathematically intuitive as well, because $2 * 40 = $80, which is precisely the extra cost.(180-100=80)

      When 2 workers are appointed, they together produce 90, we still pay extra $80, but the extra production is 50, thereby reducing the additional cost per unit to $1.6. Now, this $1.6 cost is the cost of producing the additional 50 units,(again mathematically no problems, $1.6*50 = 80, and this is again precisely the extra cost we incur) but does this mean that the prior 40 units are still being produced at $2 a unit.

      If I add the two marginal cost $1.6 +$2 = $2.6, where as Total Cost per unit is a bit greater for producing 90 units ($260/90) = $2.89.

    • Up

      Dude, no worries! nothing to be ashamed of, we’re all here to learn and avoid the same mistakes for the exams 🙂

      First, some definition: Marginal cost = the additional cost of producing an extra unit of product.

      So in the case of adding the 2nd worker, this extra person produces an extra 50 units and costs an extra $80. So the marginal cost per unit is $80/50 = $1.60. So to answer your question, it relates to the additional 50 products. At this level, the marginal cost is the lowest, adding the 3rd worker seems to produce diminishing marginal returns to production and therefore having 2 workers is optimal.

      Hope this helps, do let me know if you’ve further questions.

    • Up

      @karanv_10111‌ – I don’t fully follow your question, what part in particular that you don’t understand?

      I don’t follow the last line of your sentence: the addition of $1.6+2 should be $3.6. Care to elaborate?

    • Up

      That @Sophie is a blunder, I am ashamed of. What I really want to figure out is, the $1.6 per unit cost, is it for the additional 50 products or the total 90 products produced?

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