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.,
average cost Total cost divided by total output.
marginal or incremental cost The cost of producing an additional unit of output.