5 Min. Read

Marginal Revenue: What It Is & How to Calculate It?

May 1, 2024

It’s impossible to have a healthy and stable business without a clear understanding of concepts like gross profit, revenue, and production costs. Particularly in a competitive market, these metrics can make or break a growing company.

Marginal revenue is one area that decision-makers can use to unlock true profit maximization and success. In this guide, we’ll explore the definition of marginal revenue, show you how to calculate it, and explain why it matters for your current output.

Here’s What We’ll Cover:

What is Marginal Revenue?

How to Calculate Marginal Revenue

Why is Marginal Revenue Important?

Marginal Revenue and Marginal Cost

Key Takeaways

More Profit and Revenue Resources

What is Marginal Revenue?

Marginal revenue (MR) is the amount of money that a business or firm makes by selling one additional unit of a product. In terms of production, a single extra unit of output is all that’s needed to calculate MR.

For example, a hot dog stand may spend the afternoon selling 50 hot dogs. An additional unit, one single hot dog, sells during the last few minutes of the day. The market price of that last sale is most important for determining accurate MR.

How to Calculate Marginal Revenue

Business leaders and entrepreneurs may need to calculate marginal revenue when:

They want to achieve true profit maximization
They want to compare the sale price to production cost
They want to adjust the average price of a good or service

Fortunately, calculating marginal revenue (MR) is relatively simple once you have a single item that sells in addition to regular and expected sales.

Marginal Revenue Formula

The formula for calculating marginal revenue (MR) is relatively simple.

MR = Change in Revenue / Change in Quantity

Although you can use this formula if you have sold more than one additional item, keep in mind that you only need the selling price of one extra item to find a true calculation.

Basic Business Example

To showcase how easy it is to use the MR formula, let’s imagine a business that sells tires. In the course of normal business operations during the week, the tire company sells 50 tires and makes $2,500 in actual revenue. At the end of the week, the business offers a special promotion and sells 10 more tires, bringing in another $400.

By the end of the week, the business experienced a revenue increase of $400 through the sale of 10 extra products.

In this example, the calculated MR would be $40.

Why is Marginal Revenue Important?

Marginal revenue is important from both a single business standpoint and a broad economic perspective.

This metric is vital because it allows leaders to make better and more informed decisions about production efforts. A thorough and regular analysis of MR helps business leaders understand the increase in revenue from one additional unit of output at a specific time. Depending on the calculation, businesses can choose to halt or continue production, which has serious implications for both the supply chain and the consumer buying cycle.

From an economic standpoint, marginal revenue coincides with marginal cost in a way that establishes the standard for quantity and market price at a given time. This underlying process has the ability to affect multiple businesses across an entire industry, especially in a competitive market.

Marginal Revenue and Marginal Cost

A discussion on MR is incomplete without exploring the relationship between revenue and marginal costs. The general rule of thumb is that when the marginal cost (MC) is higher than MR, the business should consider stopping production or sales.

The reason for this abrupt change is because it is technically more expensive to continue selling the item, and the business is losing money.

Understanding the Marginal Revenue Curve

In economics, the MR is generally viewed as a straight line on a graph. It is fixed because companies earn a similar amount of revenue from each customer.

In contrast, marginal costs vary due to fluctuating expenses. When the line for MR intersects with the line for marginal costs, economists consider this the moment of maximized profit.

Profit stops when the costs begin to exceed MR on a standard line graph. At this point, the production level is too expensive, and companies usually pivot with a new strategy or stop selling a specific product.

Key Takeaways

Marginal revenue is one of many calculations that business leaders should use when scrutinizing the economic principles of their particular business model. It is also valuable for comparing a particular business, product, or service to the market at large.

In order to truly maximize both profit and revenue, businesses should implement a regular pulse check on production levels, accounting procedures, and financial decisions.