In economics, marginal cost represents the total cost to produce one additional unit of product or output. Marginal product is the extra output generated by one additional unit of input, such as an additional worker. Marginal cost and marginal product are inversely related to one another: as one increases, the other will automatically decrease proportionally and vice versa.
The relationship between marginal cost and marginal product can be attributed to the law of diminishing returns, a central concept in the field of economics. This law states that, as one continues to add resources or inputs to production, the cost per unit will first decline, then bottom out, and finally start to rise again. For example, a company may add a new worker to its manufacturing operations. This new employee helps the firm increase its total output and may also increase marginal product. After too many workers have been added, however, employees may find themselves wasting time waiting to use tools and equipment, or simply crowding one another out, resulting in a higher marginal cost.
Due to the inverse relationship between marginal cost and product, marginal product will always be at its maximum level just as marginal cost reaches its minimum point. The opposite is also true, where marginal product is at its minimum level as marginal cost reaches the maximum level. Graphically, the two are illustrated as mirror images to one another. When marginal product is at the highest possible level and marginal cost is at its lowest point, diminishing returns begin to set in, and marginal cost will begin to rise.
Marginal cost is equal to the cost of hiring an additional worker, or adding a unit of input, divided by the marginal product of that worker or unit or input. If each new worker costs $10 US Dollars (USD) and increases output by 10 units, a worker’s marginal cost can be calculated as $10 USD divided by 10 units: $1 USD per unit.
The 10th worker hired by the company still costs $10 USD, but he may only be able to produce an additional five units due to overcrowding on the production floor. His marginal cost can be calculated as $10 USD divided by five units, or $2 USD per unit. This higher marginal cost is due to the law of diminishing returns. In the long run, it may be possible to affect marginal cost and marginal product by expanding capacity and adding new machines, equipment or floor space.