Opening a business or firm is not as difficult as to keep in accelerate for the next level of success, it needs a thorough focus on every aspect. Small costs and expenses matter a lot. Two such important factors are marginal revenue and marginal cost. Marginal revenue is one of the key factors to determine the output and price per unit to get the maximum profit. Many times people often get confused between the sales price and marginal revenue, but the fact is that they are different pages of your business book.
What is marginal revenue?
Marginal revenue is defined as the additional revenue generated by increasing sales of one additional product or unit. The calculation is done by obtaining the comparison of the total revenue generated by a particular number and revenue generated by selling one extra unit. It is that extra income which the company earns after deducting the cost of production or obtaining the product itself. To understand it better, let’s take an example.
|Output||Total revenue (£)||Marginal revenue (£)|
The marginal revenue by selling the 12th unit is £200 – the difference between the total income of 12 and 11 units.
Marginal revenue plays a significant role as the maximizing profit-earning firm will produce the point where the marginal cost is equivalent to the marginal revenue.
How to calculate marginal revenue?
Formula to calculate:
Competitive Market VS Monopoly Market
In the competitive market, the chance to earn more marginal revenue is high than the monopoly market. The competitive market always gets the same price irrespective of the unit sold by the firm as the sale price never gets affected by the industry price.
It is because a firm in a competitive market will get the exact rate for each unit it sells irrespective of the number of units the firm sells as the firm’s sales can never affect the industry’s price.
While in the monopoly market, the market revenue generated is always less than the price of the firm. Due to less demand for the products, they can still face the limit. Unlike the competitive market, to maximize profit, in the monopoly market, the firm can reduce the production of goods, and can set the high price of those goods.
Another critical factor in business growth is the marginal cost. It refers to the expenses related to the cost of production of an extra unit of good produces. Some people also refer to ‘the cost of the last unit’.
Marginal Cost = (Change in Costs) / (Change in Quantity)
To find the change, consider the following formula
Change in Total cost=Total Cost of Production including additional unit – Total Cost of Production of a regular unit
Change in Quantity = Total quantity product including additional unit – Total quantity product of a regular unit
The production cost includes fixed as well as the variable cost. Fixed cost includes expenses like rent, salary or other utility costs while the variable cost varies from time to time, such as the cost of material, cost of operating machines, and additional production costs.
Let’s understand the relation between marginal cost and marginal revenue. How maximum profit can be achieved.
If the marginal revenue> marginal cost; it is the indication to increase the output
If the marginal revenue<marginal cost; it is the indication to decrease the output
The maximum profit scenario, when marginal revenue is equal to marginal cost
So, before start making plans for the maximum profit with the given formula, make sure to read the limitation of MC=MR
- It is not easy to determine the exact marginal revenue and marginal cost in reality. The reason behind this failure is that it is not easy to find the exact price elasticity of demand. With the right price elasticity, you can find the marginal revenue.
- Demand for the goods varies from one factor to another, so it is not easy to find the effect of change in price on demand.
- Your usage of profit maximization also highly depends on your competitor’s reaction and action. With the rise in the price of your product, there are chances that your competitor might also increase the price of their product. Which further leads to demand inelasticity.
- There might be another scenario, where a rise in the price of the product for the short term, may attract more firms to enter the market. This leads to more competitors and less share market for your firm.
Click here to view guidance video to calculating margin revenue.
We hope that you are now clear how to use these financial ratios to stay for a longer run in the competitive market. Did you find the post of how to how to calculate the marginal cost and marginal revenue useful? Make sure to make the best of these analyses for the maximization of profit. For all the finance-related queries and curiosities, FinanceShed is your final destination.