Further theory on marginal production costs
For a co-product (or a group of co-products) to influence and be determining for the production volume of an activity, the revenue that it provides must exceed the marginal production costs. This implies that it is necessary to know the marginal production costs of the co-production in order to identify if a specific co-product can influence the production volume on its own, or only as a part of a combination of co-products.
Information on marginal production or operation cost can be found in various engineering handbooks and other literature depending of the nature of the product.
If data on the marginal costs is not available, more qualitative considerations can be helpful:
- An extreme assumption would be that the total revenue is required and that all co-products therefore have to be seen as a bundle that has to be sold, and not even the co-product with the lowest contribution to the revenue could be thrown as way as waste. This assumption would often reveal itself as unrealistic, suggesting e.g. that beef cattle would not be produced if there were no demand for hides for leather. A common sense consideration would here suggest that the marginal production costs for beef cattle could indeed be covered from the sale of the meat alone, but not from the hides alone.
- Another extreme assumption would be that the revenue from every single co-product could cover the marginal production costs on its own, which often also will reveal itself as an unrealistic assumption: Even in cases where two products both contribute half of the revenue, it is unlikely that one of them could cover the entire marginal production costs. This would only be possible if there were really extreme co-production benefits compared to the alternative production routes that produce the two products separately. A common sense consideration would therefore suggest that only the combination of the products could cover the marginal production costs.
The marginal production costs (the variable production costs) are typically lower than the total revenue of the activity, because the fixed costs are not included. As indicated already by the qualitative considerations above, a coarse estimation will often be sufficient: An estimate for the marginal production costs can be obtained from industry statistics (or ultimately input-output tables) by subtracting the gross operating surplus from the gross revenue from all the co-products. The gross operating surplus is typically below 20% of the gross revenue, and often below 10%, which means that the marginal production costs are often above 80% of the revenue.