Marginal Revenue

What is Marginal Revenue?

The increased revenue obtained from an additional unit’s sale of a product is called marginal revenue. The word marginal always expresses something extra; so in the case of revenue, it shows the extra revenue generated. Marginal revenue follows the law of diminishing returns. According to the law, the output slows down with a gradual increase in inputs.

In the case of a perfectly competitive business, marginal revenue means to continue to produce output up to the point when marginal revenue equals the marginal cost.

Example

Suppose company ABC produces pens at the rate of Rs 10 per pen. It sells 1000 pens on Monday for 10,000 Rupees. On Tuesday, it sells 1100 pend for Rupees 11,000. Here the increase in revenue is Rs 1,000. Hence, the marginal revenue for the company is Rs 1,000.

The formulas for calculating marginal revenue are as follows −

$$\mathrm{Marginal\:revenue\:\frac{Change\:in\:revenue}{change\:in\:iquality}}$$

$$\mathrm{Marginal\:revenue\:\frac{current\:revenue\:-initial\:revenue }{current\:quality\:-\:initial quality}}$$

Marginal Revenue Calculation

Marginal revenue can be calculated using the following steps −

Calculation of Total Revenue

The first step in calculating the marginal revenue is calculating the total revenue of the company. The value of total revenue can be calculated by multiplying the total number of products sold by the price of each product.

$$\mathrm{Total\:revenue\:=\:Price\:per\:product\:\times\:Number \:of\:units\:sold}$$

For example, if the current price per product is Rs 10 and 1,000 units of the product have been sold then total revenue would be 10 × 1000 = Rs 10,000.

Performing Market Analysis

The next step in calculating the marginal revenue is to look for an alternative lower price of the product and find another total product number that could be sold in the lower price level found from the analysis. The idea here is to check the competitors in the market and find out the plausible price that can be ideal for the product being produced by the company. Usually, lowering the price increases the demand hence companies must look for an ideal price point where maximum sales could be generated.

Calculation of Alternative Revenue

Once the alternative price point is decided, finding the alternative number of products that can be sold in the market needs to be ascertained. When both of these values are found, it is time to find the alternative revenue for the product. The alternative revenue can be calculated using the following formula −

$$\mathrm{Alternative\:price\:\times\:alternative\:sales\:=\:alt\:revenue}$$

Suppose the alternative price of the pens is Rs 7 and 2,000 units of the product is sold.

Then, alternate revenue = 7 × 2,000 = 𝑅𝑠 14,000.

Applying Marginal Cost Equation

The marginal cost equation can be solved using the values obtained for alternate and original products sold.

The equation for marginal cost is −

$$\mathrm{\frac{alt\:revenue\:-\:total\:revenue}{alternative\:sales-\:current\:sales}}$$

Therefore, we now have to divide the value of total revenue subtracted from alternate revenues by the value of current sales subtracted from alternate sales.

For company ABC,

$$\mathrm{Alternative\:revenue\:=\:14,000}$$

$$\mathrm{original\:revenue\:=\:10,000}$$

$$\mathrm{Alternative\:sales\:=\:2,000\:units}$$

$$\mathrm{original\:sales\:=\:1,000\:units}$$

So, marginal cost

$$\mathrm{\frac{14, 000\:-\: 10, 000}{2,000-\:1,000}}$$

$$\mathrm{=\: Rs\:4s}$$

Analyzing the data

The value of marginal cost obtained through the above-mentioned procedure can be used to check the financial records produced by a company. It must be noted that the value of marginal cost applies to a single product. So, if a company produces more than one item, the figures of marginal cost must be derived for each product. The marginal cost obtained helps companies balance the price of the product and the number of units sold optimally.

Uses of Marginal Revenue

Comparing the output to revenue

Companies often use the marginal revenue figure to check the sales against the output of the product produced by the company. This is done to ensure that marginal cost equals the marginal revenue of the product which means that the product is sold in the market at a profitable cost which is why the revenue generated equals the extra cost of the product.

If the marginal revenue is less than the marginal cost, the company is selling the product at a cost that is loss-making for the firm. So, the company may stop producing the product.

Managing Production Costs

Marginal revenue helps the management of a company to analyze the data that can help in setting the price of the product, scheduling its production, and analyzing consumer demand. When marginal revenue is used to judge consumer demand, product wastage and shortage of production can both be eliminated. This often leads to moderate costs of manufacturing and an increase in sales.

Planning future products and checking how costs change while a new product is introduced can also be managed by calculating marginal revenues. This is usually done by noting the increases and decreases in the cost of products the company already produces.

Setting prices and production schedule

Marginal revenue also helps companies to pre-judge a usable price of a product that is going to be launched newly. The price should always be competitive so that consumers prefer it and continue to purchase the product in the future as well. Marginal revenue also helps companies realize the need for a shift in production in sync with the market demand so that loss is minimized when there is low demand in the market.

Moreover, marginal revenue helps firms to optimize the production schedule, keeping the demand and supply in sync with the production of new as well as old products.

Key Takeaways

• Marginal revenue refers to the extra revenue earned by a firm due to sales of additional products.

• One must first find out the total revenue to determine the marginal revenue of a product.

• Determining the marginal revenue helps companies set competitive prices and bring new customers to their loyal’s list.

Conclusion

Marginal revenue is an indispensable tool for businesses to set the right product prices and attract new customers. Marginal revenue helps to understand the revenue generation model of a product; so companies can use it to pre-judge the sales and determine profitability both of which are important for businesses. That is why the marginal revenue formula is so important for one and all.

FAQs

Qns 1. Which law does marginal revenue follow?

Ans. Marginal revenue follows the law of diminishing returns. According to the law, the output slows down with a gradual increase in inputs.

Qns 2. What must be first found out before calculating the marginal revenue?

Ans. One must first find out the total revenue to determine the marginal revenue of a product.

Qns 3. Give two benefits of calculating the marginal revenue.

Ans. Determining the marginal revenue helps companies set competitive prices and lure new customers.