Marginal revenue

Marginal revenue is the increase in revenue from selling one more unit of a product. It differs from the price of the product because it takes into account the effect of changes in price.

For example if you can sell 10 units at £20 each or 11 units at £19 each, then your marginal revenue from the eleventh unit is (10 × 20) - (11 × 19) = £9.

The concept is important in microeconomics because a firm's optimal output (most profitable) is where its marginal revenue equals its marginal cost: i.e. as long as the extra revenue from selling one more unit is greater than the extra cost of making it, it is profitable to do so.

It is usual for marginal revenue to fall as output goes up both at the level of a firm and that of a market, because lower prices are needed to achieve higher sales or demand respectively.

Units Total cost Cost/unit Marginal cost Total revenue Price Marginal revenue Profit
1 30 30.0 30 35 35.0 35 5
2 55 27.5 25 65 32.5 30 10
3 77 25.7 22 93 31.0 28 16
4 97 24.2 20 116 29.0 23 19
5 116 23.2 19 138 27.6 22 22
6 134 22.3 18 156 26.0 18 22
7 151 21.6 17 170 24.3 14 19
8 168 21.0 17 182 22.8 12 14
9 184 20.4 16 193 21.4 11 9
10 200 20.0 16 203 20.3 10 3

Marginal revenues and costs can be further broken down into long run and short run. This reflects times over which decisions can be made. A decision to increase output a little can be made over the short term, but a larger increase may require purchasing equipment, building a new factory etc, which takes longer.

The effect on costs of long term and short term changes are also different. For example a short term cut in output still leaves one with many fixed costs unchanged, on the other hand a long term decision to cut may allow, for example, plant closures, and therefore a reduction in those costs.

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