Marginal Revenue: Definition, Formula and Calculation Examples

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Tommy Syrmolotov
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December 24, 2021

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Marginal revenue is an accounting term that tells companies how much revenue selling an additional unit will earn for them. Conversely, the marginal revenue also tells users how much making another unit will cost. Company management uses the marginal revenue figures to determine the demand for their products, plan their production schedule, set prices for their products, and determine sales percentages.

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What is Marginal Revenue?

Marginal Revenue (MR) is the income earned from each new unit sold. Marginal revenue is closely linked with another figure, which is the marginal cost (MC). Further production of goods reaches break-even when marginal revenue equals marginal cost. However, this is not the conventional break-even. At the break-even of marginal cost and revenue, it’s time to stop selling. At this point, additional production has no benefits as there is no revenue to be made. Marginal revenue should be more than the marginal cost for the company’s additional production to make sense.

It is essential to know that the marginal cost can vary from product to product in real life and may even change at different production levels for the same product. The financial ratio calculation will remain the same regardless of the output level. 

However, since the marginal revenue equation is subject to the law of diminishing returns, it will eventually decline with increases in output level. Economic theory states that firms will continue to increase their output in a perfectly competitive economy until marginal revenue equals marginal cost.

Marginal Revenue Formula

The marginal revenue formula is the sale price of an additional unit produced less than the production costs. It is easy to calculate; to find marginal revenue, a firm can divide the change in total revenue by the change in its total output quantity.

How to calculate marginal revenue? 

As part of profit economics, to calculate the change in revenue, a company should subtract the revenue figure prior to the sale of the last unit from the total revenue figure after the sale.

formula for marginal revenue with illustration - photo

Figure 1. MR Formula

The marginal revenue calculation serves to quantify production level changes. Businesses usually use it to measure the increase in revenue by producing an additional unit, so usually the denominator is 1.

Marginal Revenue Calculation Example

Now how to calculate marginal revenue?

For example, a company increases product A production by 150 units and earns $100 in revenue. Marginal revenue will be:

$100 (change in revenue) / 50 units (change in quantity) = $2 (marginal revenue)

Another marginal revenue example:

A company generally sells 20 units for $500 but opts to sell an additional unit for $18. In this case, marginal revenue will be $18. The normal revenue of $25 ($500/20) per unit will not count as the marginal revenue definition MR is only about the additional item sold.

$18 (change in revenue)/ 1(change in quantity) = $18

How to Use Marginal Revenue?

From an economic perspective, the definition of marginal revenue means that its application allows companies and their departments to make their arguments for additional production, sales, and promotional activities. The concept of MR in microeconomics provides for using the demand curve and marginal revenue curves to plan out production cycles. This allows companies to apply different economic metrics to finalize markup pricing and other parameters like profit maximization levels and optimum production points. 

Know the impact of each extra unit on revenue

Selling more product units should lead to better revenues and marginal revenues, profitability, and lower additional costs. It is essential to know what does marginal revenue mean at different production levels. The ratio may measure revenue increment, but this can vary between the number of units produced with time, as other factors like the laws of diminishing returns play their role.

The law of diminishing returns states that production growth will yield nominal growth in output over time. This means that the company has crossed the point of its optimum production level.

The relationship between sales and market demand

Using marginal revenue figures helps companies know the relationship between their sales, market demand for their product, and market competition. Sales match customer needs, which is linked to product branding. Product demand is related to user want. 

Suppose production managers running multiple product lines on their machines must determine which product will earn them more money. Increasing the supply of a product can backfire as the market will see it as low quality or not good enough. 

Market growth and profitability come from knowing the tricky balance between demand, supply, and brand perception, along with the actual impact of marginal revenue on normal production levels.  

marginal revenue and profits graph - photo

Figure 2. Marginal Revenue and Profits

Difference Between Marginal Revenue and Marginal Cost

When marginal revenue equals marginal cost of a product, companies will stop producing additional units of the product or service. As long as the MR is more than the marginal cost (MC), additional production is profitable. The figure below shows that any quantity produced under 75 units (where the marginal cost line crosses the marginal revenue line) will be marginally profitable.

marginal cost marginal revenue graph - photo

Figure 3. Marginal Revenue and Marginal Cost

Again, just like marginal revenue is the money made from each additional sale, marginal cost is the cost of producing an additional unit. The figure above shows that further production of units up to the profit maximization point will be profitable as the MC falls below the MR line. 

Final Thoughts

Marginal revenue (MR) is the income from each new unit sold. Marginal revenue is linked with another ratio; the marginal cost (MC). Further production of goods reaches break-even when marginal revenue equals marginal cost. However, this is not the conventional break-even. Here the break-even means that the additional production or sales are not increasing profits.

It is essential to know that the marginal cost can vary from product to product in real life and may even change at different production levels for the same product. The financial ratio calculation will remain the same regardless of the output level. 

So, what does marginal revenue mean for businesses? The mr equation by definition tells us the additional profit we will make from selling an additional unit of our product. For instance, if you make 12 dozen cupcakes on your own and are considering an order which will require that you bake 15 dozen cupcakes. Baking the additional cupcakes requires hiring someone for 3 hours to help you with the extra work and buying more raw materials than usual, which will mean an additional delivery charge. The total additional cost of the three dozen cupcakes is:

example calculation of marginal cost about cupcakes - photo

This means that you shouldn’t take the order without a rate increase, or reducing your delivery charges, or hiring someone cheaper to help you out. Otherwise, you manage your workflow to manage without extra delivery or a helper if you want to make a profit.

This is the beauty of the marginal revenue formula. It tells you the reality behind additional sales and how profitable they are in economic terms and revenue price. In more advanced cases, knowing how to find mr in economics terms allows companies to make capital expenditure and promotional campaign decisions. 

Knowing how to find marginal revenue can help in individual decisions as well. The costs of going for a new job, how much you will earn from it, and how much you will spend to get there (maybe there’s a long commute or an uncompensated residence shift) can help evaluate your decision better. 

FAQ

What is the definition of marginal revenue?

Marginal revenue is revenue earned from an additional sale of a unit. The mr equation allows profitability calculations and assists in decision making.

What is the difference between total revenue and marginal revenue?

Total revenue is the total sales of a firm for the total units it sells. Meanwhile, marginal revenue tells us how much a single unit will earn.

Can the marginal revenue change for the same product?

The marginal revenue can change from product to product in real life and it can also change at different production levels for the same product.

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