A company calculates Marginal Revenue by dividing the change in revenue by the change in quantity. For example, a company that increases production by 100 units receives $100 in revenue. By dividing the 100 units by $100, the marginal revenue is calculated.
In other words, MR is calculated by dividing the change in total revenue by the change in total output quantity. Therefore, we can look at each additional item sold as MR.
For example, a firm may sell 50 products for $500. If the 51st item sells for $6, then its MR is also $6. As a result, the average price of $10 is ignored, with MR only looking at the next item sold or the incremental change.
Marginal Revenue (MR) is the money a firm makes for each additional unit sold. For example, when a consumer goes to Walmart and pays $20 in groceries, that is MR – because the groceries purchased were new and marginal sales.
So anything sold can be considered as MR. However, the purpose of MR is to calculate the change in revenue after a certain point. For example, there is a business called Bobs Bicycles that sells bicycles. The company usually sells 100 bikes a week for $50,000. Bobs Bicycles undertakes a promotional campaign that boosts sales to 120 bikes a week, earning the company a total of $70,000.
In this example, total revenue increased from $50,000 to $70,000, meaning revenue increase by $20,000. At the same time, the quantity sold increased from 100 to 120, meaning an increase of 20. So revenue increased by $20,000 and quantity by 20. We therefore divide revenue ($20,000) by quantity (20), to get $1,000. So the MR achieved from each sale was $1,000.
This calculation is important for businesses as they need to ensure that MR does not fall below Marginal Cost (MC). When it does, it means that the business is losing money – because it is costing more than what it is able to sell the product or service for.
Marginal Revenue is shortened to ‘MR’ in economics to make it easier to view on charts. As we can see below, MR is stable and consistent. This is because, for each good sold, the business makes the exact same amount from each customer. By contrast, Marginal Cost (MC) can vary. Some businesses may benefit from economies of scale, which lower its costs.
However, businesses may also experience an increased level of inefficiencies. This may just be just bad business management, or it could suffer from diseconomies of scale. In turn, MC starts to increase. As we can see from the chart, there is a point where MR and MC intersect. It is at this point where it becomes unprofitable for the business to produce any more.
When Marginal Revenue (the money a firm makes from each additional sale) equals Marginal Cost (the amount it costs a firm to produce an additional unit), firms will stop producing the product / service. So when MR is larger than Marginal Cost (MC), then the firm is making money.
When MC = MR, we have what is known as profit maximisation. After this point has been reached; the firm cannot make any more profit. It is therefore in their interest to stop production.
How do you calculate the marginal revenue?
Marginal revenue (MR) is calculated by dividing the change in total revenue by the change in total output quantity. Therefore, we can look at each additional item sold as MR. For instance, a firm may sell 50 products for $500. If the 51st item sells for $6, then its MR is also $6. As a result, the average price of $10 is ignored, with MR only looking at the next item sold or the incremental change.
Definition: Marginal revenue (MR) is the additional revenue gained from selling one extra unit in a period of time.
- Marginal revenue (MR) = Δ TR/Δ Q
- If a firm sells an extra 50 units and sees an increase in revenue of £200. Then the marginal revenue of each extra unit sold is £4
Example of Marginal Revenue
This shows the price (P), quantity (Q), total revenue (TR) average revenue (AR) and marginal revenue (MR)
If the firm cuts the price from £7 to £6, quantity increases to 5. Total revenue increases by two. Therefore the marginal revenue is two.
If the firm cuts price from £3 to £2, total revenue falls by six. Therefore, the marginal revenue is -6.
Marginal revenue and revenue maximisation
If a firm wished to maximise revenue, it can use marginal revenue to guide its decision. If marginal revenue is positive, the total revenue is increasing.
If marginal revenue is negative, total revenue is decreasing.
In this example, revenue is maximised at a quantity of 5.
Marginal revenue and profit maximisation
- To maximise profits, a firm needs to consider both marginal revenue and marginal cost.
- If marginal revenue is greater than marginal cost, then total profits will be increasing.
- Profit will be maximised at the point where MR=MC
Example
In the real world, an airline may sell some last-minute tickets for a very low price. The marginal revenue may be quite low. However, the marginal cost of selling empty seats on a plane is also quite low.
Marginal revenue and Marginal revenue product
A firm’s demand curve for labour depends on the marginal revenue of the last good sold and the marginal physical product of an extra worker.
MRP = MPP x MR.
Relationship between average revenue and marginal revenue.
If the firm is a price taker, its demand curve will be perfectly elastic. In this case, the marginal revenue will be the same as the price and average revenue.
If the price is £5, then the addition to revenue (MR) for selling an extra good, will always be equal to the price £5
Marginal revenue in monopoly
When a firm faces a downward-sloping demand curve, then marginal revenue will be less than average revenue and can even be negative.
This is because, if a firm cuts price, it gets a lower average price but also loses revenue it could otherwise have made from selling units at a higher price.
Marginal revenue and elasticity
- However, if a firm cuts price and marginal revenue is negative (total revenue falls). This implies that demand is price inelastic. (% change in demand less than % change in price)
- At quantity of 6, where MR = 0, at this point, PED = 1 (unitary elasticity)
- This shows the elasticity of demand for a straight line demand curve varies.
Related
- Profit maximisation
- What determines pay?
- Marginal cost
Published 12 May 2020, Tejvan Pettinger. www.economicshelp.org