What is Marginal Revenue?

Definition of Marginal Revenue in Microeconomics

Branch with money leaves resembling a graph
Branch with money leaves resembling a graph. Getty Images/David Malan/Photographer's Choice

In microeconomics, marginal revenue is the increase in gross revenue a company gains by producing one additional unit of a good or one additional unit of output. Marginal revenue can also be defined as the gross revenue generated from the last unit sold.

Marginal Revenue in Perfectly Competitive Markets

In a perfectly competitive market, or one in which no firm is large enough to hold the market power to set price of a good, if a business were to sell a mass-produced good and sells all of its goods at market price, then the marginal revenue would simply be equivalent to the market price.

But because the conditions required for perfect competition, there are relatively few, if any, perfectly competitive markets in existence.

For a highly specialized, low output industry, however, the concept of marginal revenue becomes more complex as a firm's output will affect the market price. That is to say in such an industry, the market price will decrease with higher production and increase with lower production. Let's take a look at a simple example.

How to Calculate Marginal Revenue

Marginal revenue is calculated by dividing the change in total revenue by the change in production output quantity or the change in quantity sold.

Take, for example, a hockey stick manufacturer. The manufacturer will have no revenue when it doesn't produce any output or hockey sticks for a total revenue of $0. Assume that the manufacturer sells its first unit for $25. This brings marginal revenue to $25 as the total revenue ($25) divided by the quantity sold (1) is $25.

But let's say the firm must lower its price to increase sales. So the company sells a second unit for $15. The marginal revenue gained by producing that second hockey stick is $10 because the change in total revenue ($25-$15) divided by the change in quantity sold (1) is $10. In this case, the marginal revenue gained will be less than the price the company was able to charge for the additional unit as the price reduction reduced unit revenue.

Another way to think of marginal revenue in this example is that the marginal revenue is the price the company received on the additional unit less the revenue lost by reducing the price on the units that had been sold prior to the price reduction.

Marginal revenue follows the law of diminishing returns, which holds that in all production processes, adding one more production factor while holding all other production factors constant will eventually generate lower per-unit returns due to inputs being used less efficiently.

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