To talk sensibly about costs, we need a clear vocabulary. At the core of that vocabulary are the concepts of average cost and incremental cost. Average cost equals the total cost of a process divided by the total output of a process. In exhibit 5.3, when total cost equals $10,500 and output equals 300, aver- age cost equals $35. Incremental cost, also called marginal cost, equals the change in a process’s total cost that is associated with a change in the pro- cess’s total output. In exhibit 5.3, total cost rises from $8,000 to $10,500 as output rises from 200 to 300, so incremental cost equals ($10,500 − $8,000) ÷ (300 − 200), or $25 per unit of output.

In exhibit 5.3, average cost is significantly larger than incremental cost. This difference is common because many processes require resources (e.g.,

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average cost Total cost divided by total output.

marginal or incremental cost The cost of producing an additional unit of output.