What is Marginal Revenue?
Marginal revenue is the additional revenue generated by selling one more unit of a product or service. It is a key concept in economics and business, particularly in the realms of price discrimination, market structures, and profit maximization strategies. Understanding how marginal revenue works can help businesses set optimal pricing levels, forecast financial outcomes, and strategically plan their production and sales activities.
Formula: \[ \text{Marginal Revenue (MR)} = \frac{\Delta TR}{\Delta Q} \]
Where:
- \(\Delta TR\) = change in total revenue
- \(\Delta Q\) = change in quantity sold
Examples of Marginal Revenue
Example 1: Simple Calculation
Imagine a company sells 100 widgets at $10 each, yielding a total revenue of $1,000. By selling an additional widget (the 101st unit) for $9, the total revenue becomes $1,009. The marginal revenue for the 101st unit is: \[ \text{MR} = \frac{$1009 - $1000}{101 - 100} = $9 \]
Example 2: Real-World Application
A popular streaming service has different subscription tiers. The service considers adding a new premium feature for an extra $2 per month per user. If they estimate that 1,000 users will opt for the premium feature, the marginal revenue from this additional feature will be: \[ \text{MR} = 1,000 \times 2 = $2,000 \]
Frequently Asked Questions (FAQ)
What is the difference between marginal revenue and total revenue?
Total revenue is the overall income a company earns from selling its goods or services. Marginal revenue focuses solely on the additional income generated by selling one extra unit.
Why is marginal revenue important for businesses?
Marginal revenue is crucial because it helps businesses determine the impact of their pricing and sales decisions. It informs whether producing and selling additional units will contribute positively to profits.
How does marginal revenue relate to marginal cost?
Marginal revenue should ideally be compared with marginal cost (the cost of producing one additional unit) to determine profitability. If marginal revenue exceeds marginal cost, a business should continue to produce more units.
What happens to marginal revenue in a perfectly competitive market?
In a perfectly competitive market, marginal revenue is equivalent to the market price. Firms are price takers and cannot influence the market price by changing their output levels.
How does price elasticity affect marginal revenue?
If a product is price elastic (elasticity > 1), lowering the price can increase total revenue, making marginal revenue positive. Conversely, if a product is price inelastic (elasticity < 1), lowering the price may decrease total revenue, resulting in negative marginal revenue.
Related Terms with Definitions
Total Revenue
Total revenue is the total income generated from the sale of goods or services before any costs or expenses are deducted.
Marginal Cost
Marginal cost is the increase in total cost that arises from producing one additional unit of a product.
Price Elasticity of Demand
Price elasticity of demand measures how much the quantity demanded of a good responds to a change in its price.
Profit Maximization
Profit maximization is a process where a firm determines the price and output level that returns the greatest profit.
Average Revenue
Average revenue is the average income earned per unit of output sold, calculated by dividing total revenue by the quantity sold.
Online References
- Investopedia: Marginal Revenue
- Khan Academy: Marginal Revenue and Marginal Cost
- Corporate Finance Institute (CFI): Marginal Revenue
Suggested Books for Further Studies
- “Managerial Economics: Applications, Strategy, and Tactics” by James R. McGuigan, R. Charles Moyer, and Frederick H. deB. Harris
- “Microeconomic Theory: Basic Principles and Extensions” by Walter Nicholson and Christopher M. Snyder
- “Economics for Managers” by Paul G. Farnham
- “The Economics of Business” by Frank S. T. Hsiao
Accounting Basics: “Marginal Revenue” Fundamentals Quiz
Thank you for diving into this comprehensive exploration of marginal revenue. Remember, grasping these concepts can empower you to make informed and strategic business decisions.
