Why Is a Supply Curve Referred to as a Marginal Cost?

The supply curve shows the different prices at which businesses are willing to offer their products. Typically, a business has greater incentive to offer more products if it is guaranteed a higher value in return. For example, a farmer will choose to plant more corn if the price received from selling corn is high. However, the willingness of the farmer to sell more corn depends on the additional cost of planting that corn -- costs such as land lease, fertilizer expenses or the extra labor needed. Hence, the supply will depend on the extra cost of production of these extra units, also known as the marginal cost.

Marginal cost to a business is the extra cost incurred in making one more unit of a product. It is calculated by dividing the change in total cost by the change in total output. If the farming business above doubled its production of corn from 50 bags to 100 bags and thus raised its total cost from $200 to $400, its marginal cost of production would then be $4 ($400 minus $200 divided by 100 minus 50). The marginal cost usually falls at the start of a business because the business is using resources most efficiently. However, running up against land or machine capacity levels will cause marginal costs to rise. Businesses are most inclined to supply additional quantities of a product if the price received covers those rising marginal costs.

The basic rule of thumb for any successful business is to set the price of a product where the business can make a profit or at least be able to cover its costs. Using the example of the farming business, the farmer will only supply additional bags of corn if he receives enough revenue to cover the extra cost. If the extra cost of doubling production is $4, he would expect to at least receive $4 from selling the additional produce on the market. In effect, the additional cost -- the marginal cost -- can be seen as the lowest price at which a business is willing to supply additional units to the market.

Industries that make homogeneous products -- like corn farmers who raise corn -- have a hard time implementing sales techniques such as price differentiation. Unlike other industries that may benefit from having product brands, most farming products are too similar to be successfully differentiated. Corn is the same from one farmer to another, so one seller can't secure a higher price for her brand. Because the product is so uniform and so widely available, the price that farmers can charge at the very minimum is the cost of producing that food product. So the exact price received by a corn supplier will be the extra cost -- the marginal cost -- involved in producing that product.

Businesses make a profit if the price per product exceeds its cost. If the price charged was the same as its cost, the business makes no profit but can at least cover its expenses. Even a business that is running at a loss can still afford to operate as long as it can pay its workers. If the business cannot cover its employees’ wages and operational costs, it is likely to shut down. Using the farming example, the farmer would have to quit if the price received for each bag of corn couldn't cover the extra hourly wage required to plant or harvest that output. The business will stop supplying products when the product's price is so low that it cannot cover its costs.