Incremental cost represents the additional cost incurred for producing an extra unit of output or for implementing a change to the current operations. For example, when a company manufactures one more unit of a product, the cost of raw materials, additional labor, and usage of utilities beyond the current cost base constitutes the incremental cost. This concept plays a significant role in decision-making, as it helps organizations determine the cost-effectiveness of scaling production or introducing a new service. By understanding incremental costs, businesses can identify profitable activities and optimize their operations.

For example, if the production cost of producing 100 gadgets is $500 and producing 101 gadgets costs $506, the incremental cost associated with producing the 101st gadget is $6. Incremental cost analysis is often used in conjunction with cost-benefit analysis to assess the potential financial implications of changes.