What does one more cost?
Average cost is a report. Marginal cost is a decision. Confusing the two is how a profitable order gets refused.
You make a product. It costs you $24 in materials and labour for each one, and you carry $6,000 a month of rent, salaries and software whether you sell one or a thousand. Last month you sold 500 at $40.
A buyer calls. They want 100 units, one-off, and they will pay $30 each.
Finance says no. Here is their arithmetic, and it is correct:
$30 is less than $36. Selling below cost. Refuse the order.
This reasoning costs the company $600, and it is worth understanding exactly why.
The fixed cost is already gone
The $6,000 does not care about the order. You pay it if you accept, you pay it if you refuse. It is not part of the decision — it has already been decided.
So the real question is not what did a unit cost? It is: what changes if I say yes?
| Refuse the order | Accept the order | Difference | |
|---|---|---|---|
| Units made | 500 | 600 | +100 |
| Variable cost | $12,000 | $14,400 | +$2,400 |
| Fixed cost | $6,000 | $6,000 | no change |
| Revenue | $20,000 | $23,000 | +$3,000 |
| Profit | $2,000 | $2,600 | +$600 |
Units made
- Refuse the order
- 500
- Accept the order
- 600
- Difference
- +100
Variable cost
- Refuse the order
- $12,000
- Accept the order
- $14,400
- Difference
- +$2,400
Fixed cost
- Refuse the order
- $6,000
- Accept the order
- $6,000
- Difference
- no change
Revenue
- Refuse the order
- $20,000
- Accept the order
- $23,000
- Difference
- +$3,000
Profit
- Refuse the order
- $2,000
- Accept the order
- $2,600
- Difference
- +$600
One more unit costs $24 to make and brings in $30. That is $6 of profit, a hundred times over.
Two costs, two jobs
| What it is | What it is for | |
|---|---|---|
| Average cost | total cost ÷ units — $36 | reporting. It tells you how last month went. |
| Marginal cost | the cost of one more unit — $24 | deciding. It tells you what to do next. |
Average cost
- What it is
- total cost ÷ units — $36
- What it is for
- reporting. It tells you how last month went.
Marginal cost
- What it is
- the cost of one more unit — $24
- What it is for
- deciding. It tells you what to do next.
The rule: do it while the extra benefit is bigger than the extra cost. Not the average benefit — the extra one.
Where this bites
The same shape turns up every time someone divides a total by a count and then makes a decision with the result:
- The empty seat. A flight costs $30,000 to operate and carries 150 people — $200 a seat. Ten minutes before the doors close, an empty seat costs the airline almost nothing to fill. Any price above the cost of one more meal beats flying it empty.
- The extra student. A course costs $50,000 to build and 200 people take it — $250 each. The two-hundred-and-first pays for itself the moment they cover the payment processing.
- The rush job. "We can't take it, we'd be working below our hourly rate." If the team is paid anyway and would otherwise be idle, anything above the extra materials is money you did not have.
The mirror-image mistake. Marginal thinking says yes a lot, so it is easy to over-apply. It holds only while the fixed cost really is fixed. Fill the factory and the next order needs a second shift — and that shift is a new cost the decision does cause. Should we run the discount? ends on exactly that question.
The habit
Whenever someone justifies a decision with a number that came from dividing, ask what changes if we say yes. Then count only the things that move.
Next: the cost that never appears on any invoice — and the reason the second hour of anything is worth less than the first.