Definition of shadow price

maximum price that management is willing to pay for an extra unit of a given limited resource. Management may wish to know whether it pays to add capacity in a particular department. It would be interested in the monetary value to the firm of adding, say, an hour per week of assembly time. This monetary value is usually the additional Contribution Margin (CM) that could be earned. This amount is the shadow price. A shadow price is, in a way, an opportunity cost-the CM that would be lost by not adding an additional hour of capacity. To justify a decision in favor of a short-term capacity decision, the decision maker must be sure that the shadow price exceeds the actual price of that expansion. For example, suppose that the shadow price of an hour of the assembly capacity is $8.75 while the actual market price is $9.50. That means it does not pay to obtain an additional hour of the assembly capacity.