Marginal Revenue Guide: How to Understand Marginal Revenue

In microeconomics, marginal revenue is a business’s revenue from selling an extra product unit. The additional revenue will change depending on the additional unit’s production price (and hence, the selling price). This concept is relevant when a business changes one factor in the production process.

The business compares the revenue difference between the original amount of output of the marginal revenue product with the projected new output to assess whether a production change is cost-effective. In a competitive market, a business can incrementally increase the sale price of its product to compensate for the extra production costs without affecting the demand curve or the number of units sold.

Marginal revenue is calculated by dividing the change in total revenue by the change in total output quantity:

Marginal Revenue = Change in Total RevenueChange in Quantity

Change in total revenue reflects the total profit after adding new units, and the change in quantity reflects the total number of added units.

Say you sell handmade scrunchies for $20 each. You can make 25 scrunchies from one bolt of fabric ($20) and one spool of elastic ($10). It takes you about twenty minutes to make one scrunchie on your hand-me-down sewing machine ($0) and you pay yourself a salary of $15 an hour. The total production cost associated with making 25 scrunchies is $155, or $6.20 per scrunchie. You decide to sell the 25 scrunchies for $10 each, making your business a profit of $95.

You’re considering upping your scrunchie output, but want to know if it’s worthwhile. To calculate the marginal revenue of selling more scrunchies, you start with your production costs. You can get a larger bolt of fabric to make 50 scrunchies ($40) and benefit from a two-for-one deal on elastic spools ($10). The total production cost associated with making 50 scrunchies is $300. If you continue to sell the scrunchies for $10 each, your total revenue will be $200. The change in total revenue is $105. The change in quantity is 25.

Marginal Revenue = 10525= 4.2

Scaling your business will provide a marginal revenue of $4.20, meaning each new unit will make your scrunchie business an additional $4.20.

Marginal revenue is used to calculate the financial benefits of producing a higher quantity of products than a firm has produced in the past. Companies will typically produce additional units of a product until the marginal revenue equals the marginal cost, at which point adding more units will lower the profitability associated with producing the additional units.

Competitive firms can typically match the marginal cost of producing additional products with the marginal revenue gained from selling them. This is because competitive market prices dictate the sales price of their goods.

In a perfectly competitive market, these companies can use marginal revenue to recoup the increase in their marginal costs resulting in a marginal benefit. In such an economic climate, consumers will continue to purchase the goods in spite of a price change. However, in an economy with monopoly competition, the economic power will be able to lower its prices and impact the overall average price of a good, impacting consumer demand and starving out the competition.

Companies use marginal revenue to analyze their options to maximize earnings while preserving savings, called a cost-benefit analysis. Marginal revenue is also crucial for monopoly companies to ensure profit maximization. Monopolies have an incentive to lower prices to increase demand for their products.

For small businesses or non-monopoly companies, higher prices typically generate a revenue increase if the marginal revenue continues to equal or exceed the total cost of production. Every additional unit of output affecting the sale price must be accounted for to ensure that marginal revenue either equals or exceeds the total costs.

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