To understand why this statement is true for every situation after the first unit is produced, it is necessary to understand exactly what variable cost is. As the name implies, variable cost varies with the level of output produced. For instance, in a bakery, to produce one incremental unit of bread requires some additional flour, eggs and water. Thus, the total costs of these items will vary with each additional production of units, or loaves of bread.
Let’s say the unitary variable cost of these ingredients for the production of one loaf is $1.00. If the entire bag of flour costs $10 and each bag has enough flour to produce 20 loaves, then the flour component of each unitary cost of production is $0.50 ($10 divided by 20 loaves). The $1.00 variable cost covers the cost of all of these ingredients together plus any other ingredient (salt, for example) required to produce one unit.
Variable cost does not include costs such as rental of the bakery facilities, as that is a fixed amount that will not change regardless of whether the bakery produces 10 loaves or 1,000 loaves. Variable costs or VC is derived by multiplying total output by the unitary cost of production.
The incremental cost is the cost of each incremental or additional unit. Essentially, it is the unitary cost of $1.00 in the bakery example. Therefore, incremental cost equals total VC when the output is one unit.
To produce 1 unit, VC would be 1 x $1.00 (from our example) = $1.00, which is also the incremental cost.
At all levels above one unit, total VC is greater than incremental cost, as illustrated below.
To produce 10 units, VC would be 10 x $1.00 (from our example) = $10