How to Calculate Marginal Revenue

According to a basic tenet of economics, if a company reduces the price of a product it sells, it will sell more products, but make less money for each product. This “additional money” — the amount of revenue that comes from selling one more product — is marginal revenue.

Table of Contents

Calculate marginal revenue

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Find the total revenue using the equation:

$total revenue$ $=$ $Current price of each product$ $x$ $Current number of products sold$ ${displaystyle {text{Total sales}}={begin{aligned}{text{Current price per item}}x {text{Current number of products sold}}end{aligned}}}$ ${displaystyle {text{Total sales}}={begin{aligned}{text{Current price per item}}x {text{Current number of products sold}}end{aligned}}}$

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Consider the lower variable price and determine the quantity of product sold at that price. This step requires specific market analysis.

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Find alternative revenue using the equation:

$Replacement revenue$ $=$ $($ $Replacement price$ $)$ $($ $Number of products sold for replacement$ $)$ ${displaystyle {text{Alternative sales}}=({text{Replacement price}})({text{Alternative sales}})}$ ${displaystyle {text{Alternative sales}}=({text{Replacement price}})({text{Alternative sales}})}$

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Calculate marginal cost using the equation:

$Marginal costs$ $=$ $Replacement revenue$ $-$ $Initial revenue$ $Number of products sold for replacement$ $-$ $Current number of products sold$ ${displaystyle {text{Marginal cost}}={frac {{text{Replacement revenue}}-{text{Initial revenue}}}{{text{Replacement sales}}-{text {Current number of products sold}}}}}$ ${displaystyle {text{Marginal cost}}={frac {{text{Replacement revenue}}-{text{Initial revenue}}}{{text{Replacement sales}}-{text {Current number of products sold}}}}}$ .
In other words, marginal revenue is the change in revenue for each additional product sold.

Marginal Revenue Analysis

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Start with the right data. Typically, you’ll have to access a company’s inventory or sales reports to determine how many products it sells. Finding the replacement price when selling an additional product is much more difficult and requires skill in market analysis.

Note, marginal revenue is only useful when analyzing a product. Some reports only list data for each product group.

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Avoid negative marginal revenue. Negative marginal revenue means that the company will reduce its revenue if it lowers the price of the product. In this case, selling more products will not compensate for the reduction in the selling price per product.

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Compare with marginal cost to determine profit. Firms that maintain an optimal balance between selling price and revenue typically have an output level where marginal revenue equals marginal cost. Marginal cost is the cost that the firm produces one more unit of output. ^{[1] X Research Source}

$Marginal costs$ $=$ $Replacement cost of production$ $-$ $Current production cost$ $Number of products sold for replacement$ $-$ $Current number of products sold$ ${displaystyle {text{Marginal cost}}={frac {{text{Replacement cost of production}}-{text{Current cost of production}}}{{text{sold substitutes} }-{text{Current number of products sold}}}}}$ ${displaystyle {text{Marginal cost}}={frac {{text{Replacement cost of production}}-{text{Current cost of production}}}{{text{sold substitutes} }-{text{Current number of products sold}}}}}$ .
For example, Kim’s Soda produces 200 cans of soda at a cost of $50. Kim can spend $60 to produce 225 cans. $Marginal costs$ $=$ $60$ $-$ $50$ $225$ $-$ $200$ $=$ $$$ $0$ $,$ $40$ ${displaystyle {text{Marginal cost}}={frac {60-50}{225-200}}=$0.40}$ ${displaystyle {text{Marginal cost}}={frac {60-50}{225-200}}=$0.40}$ . Kim’s soda will only execute this plan if its marginal revenue is equal to or greater than $0.40.

Understanding different market structures

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Understand marginal revenue in a perfectly competitive market. In the above example, we consider a simplified market model, which is considered to have only one firm without competitors (monopoly). ^{[2] X Source of Research} However, it is common for companies to keep prices low due to competitive pressure. In a perfectly competitive market, marginal revenue does not change with the quantity sold, because the price of the product is fixed.

For example, Kim, the soda company in the example above, now has to compete with hundreds of other soda manufacturers. The price of each soda is $0.50 — if the price is lower, Kim’s will lose, and if it is higher, customers will choose to buy other products. Marginal revenue is always $0.50 because Kim cannot sell at any other price.

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Understand marginal revenue in a monopolistically competitive market. In fact, the small firms that create highly competitive environments are actually not perfect. They don’t react immediately to each other’s price changes, they don’t know the competition they’re facing, and they don’t always set a profit-maximizing price. This type of market system is called “monopoly competition.” Marginal revenue typically declines with each additional product sold, although not as deeply as in a monopoly market.

For example, Kim reduced the selling price of 1 can of soda from $1 to $0.85. They may still get extra revenue, but in an oligopolistic market the customer will still buy the competitor’s soda at a higher price.

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Know about marginal revenue in oligopolistic markets. In the oligopolistic market, there are a few large firms competing with each other for control of the market. Marginal revenue often tends to decrease with each additional unit sold, as in a monopoly market. However, in reality, firms in the oligopolistic market often do not want to lower their prices, because this can lead to a price war that reduces profits for all. ^{[3] X Source of Research} Usually, the large firms in a oligopolistic market will simply lower their prices to keep a smaller competitor out of the market, then they will raise prices together to increase profits for the company. all. ^{[4] X Source of Research} If firms in an oligopolistic market agree to set such a price, the level of revenue will depend on advertising and other factors, not on price.

Kim has become a major soda maker, and now shares the market with Linda and Andy, two other soda makers. These three firms agree to sell soda at the same price, so that the marginal revenue for each additional can of soda won’t change, no matter what price they choose. If Jeff started a small firm to sell soda at a lower price that competed with their inflated prices, the three firms could reduce the price of the product so low that Jeff was forced to shut down. These firms accept a temporary decrease in marginal revenue because they can raise prices again after they have eliminated Jeff from the playing field.

Steps

Calculate marginal revenue

Marginal Revenue Analysis

Understanding different market structures

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