This information is of great help in making pricing decisions.
If the selling price is less than the variable cost (direct cost),
- the loss will increase as more units are sold, and
- managers will only want to do this in very exceptional circumstances, such as a supermarket selling baked beans as a loss leader.
If the selling price is greater than the variable cost,
- then the margin will absorb part of the fixed cost, and,
- after a certain point profits will be made.
Why some goods are sold very cheaply at certain time?
Marginal costing explains why some goods and services are sold very cheaply.
It explains,f or example, why airline tickets are sometimes available at extremely low prices for last-minute purchasers.
- Once an airline is committed to making a flight, an extremely high part of the cost of that flight can properly be regarded as a fixed cost. The pilot's salary will be the same whether the plane is empty or full.
- The variable cost (direct cost) is only the complimentary meals and few other items.
- It therefore makes sense to make last-minute sales of unsold seats at low prices.
- As long as the selling price is greater than the variable cost, a contribution is made (absorbing part of the fixed cost).