What Is Marginal Revenue?
Let me explain marginal revenue directly to you: it's the increase in revenue you get from selling one additional unit of your product or service. While it might stay constant for a while as you ramp up output, it eventually follows the law of diminishing returns and starts to decrease as production levels rise. Remember, this is different from profit because it only accounts for the income side and ignores any production or sales expenses.
Key Takeaways on Marginal Revenue
As a business owner, you can use marginal revenue to figure out how much extra revenue each additional unit brings in. It follows diminishing returns, which you can see on a graph as a downward slope, meaning you'll often need to drop prices to sell more. To hit maximum profits, keep producing until your marginal revenue matches your marginal cost. If it drops below that, the cost of making more units exceeds what they bring in, so you'd typically stop production there.
How Marginal Revenue Works
You need to understand how marginal revenue operates in your business: it's what helps you calculate the extra revenue from producing and selling one more unit. Since prices depend on supply and demand, marginal revenue usually changes based on how many units you've already sold—for most things, more supply means lower prices, so as you produce more, marginal revenue drops.
By looking at your current and past marginal revenue data, you can get a handle on consumer demand, plan your future production, and set prices that make sense. Typically, we talk about marginal revenue for just one extra unit, like the revenue jump from the 100th to the 101st item, but you can also apply it to batches, say from 100 to 200 units.
Here's an important point: if marginal revenue turns negative, your total revenue actually decreases with more production and sales, which usually happens when you have to slash prices hard to move the extra units.
Marginal Revenue Curve
Visualize the marginal revenue curve as a downward-sloping straight line on a graph, with price on the y-axis and quantity on the x-axis. This slope comes from the fact that lower prices boost demand, while higher prices cut it back, so to sell more, you often have to reduce prices, which lowers the marginal revenue per unit.
If you keep cutting prices, eventually marginal revenue falls below marginal cost, making further production unprofitable. On a graph, marginal revenue is the lower downward line, marginal cost slopes up, and the sweet spot for production quantity is where they meet—that's your ideal output level, with the corresponding price on the demand curve.
Average Revenue Curve
Average revenue is simply your total revenue divided by the number of units sold, and you can compare it to marginal revenue across different quantities. In perfect competition, where you're a price-taker and the market sets a fixed price like $20 per unit, marginal revenue equals both average revenue and price since everything stays constant no matter how much you produce.
But in imperfect competition, to sell more, you drop prices, so marginal revenue ends up lower than average revenue and decreases with each extra unit. Both curves slope down, but marginal revenue's slope is steeper, dropping faster. For instance, if you sell one item for $100 and the second for $50, marginal revenue on the second is $50, but average is $75.
A quick fact: for a monopoly, average revenue is total revenue over units sold, and graphs for things like agricultural chemicals in imperfect markets show marginal revenue falling quicker than average as prices drop to sell more.
How to Calculate Marginal Revenue
To calculate marginal revenue, divide the change in total revenue by the change in quantity—it's best for single-unit jumps, but you can average it over larger batches too. The formula is Marginal Revenue = Change in Revenue / Change in Quantity, or MR = ΔTR / ΔQ.
Example of Marginal Revenue
Take this example: if you sold 100 units for $1,000 one week and 115 for $1,100 the next, the revenue change is $100 over 15 units, so marginal revenue is $100 / 15 = $6.67 per unit for those extra ones.
Marginal Revenue vs. Marginal Cost
When marginal revenue beats marginal cost, you're profiting—like if an extra unit costs $80 to make but sells for $100, that's $20 profit. Aim for where they equal; beyond that, if cost hits $110 against $100 revenue, you're losing $10 per unit, so stop producing.
The Bottom Line
In summary, marginal revenue is the extra revenue from one more unit, and you should produce until it equals marginal cost—past that, costs outpace revenue and kill profits. No matter your industry, this helps you find the right production level, especially when lowering prices reduces marginal revenue and signals when to halt to protect your bottom line.
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