Meaning and definition of Marginal Revenue
Marginal revenue refers to the increase in revenue resulting from the sale of one extra unit of output. Many of the competitive firms continue to produce output until marginal revenue equals marginal cost. However, although marginal revenue can remain constant over a particular level of output quantity, it follows the law of diminishing returns and eventually slows down, with an increase in the output level.
Investopedia illustrates Marginal Revenue with the following example wherein a company producing brooms earns total revenue of $0, when not producing any output. The revenue received from production of the first broom is $15, bringing in marginal revenue to $15. If the revenue from the second broom is $10, the marginal revenue thus gained is $10.
Calculating the Marginal Revenue
The main steps involved in computing marginal revenue include:
- Review the formula for marginal revenue as:
MR (2 products) = TR (2 products) – TR (1 product)
Where, MR signifies marginal revenue, and
TR is the total revenue
This formula computes the marginal revenue of one product over two products. Putting another way, it is the additional revenue received by a firm on producing two products instead of one.
- Work through an example. Let us presume that company XYZ is selling a product for $5, the revenue for two products thus coming to $10.
- Substituting these variables into the equation mentioned above, we get MR = $10 - $5, which is equal to $5. Thus, the marginal revenue for the second product is $5.
- Working through another example, where the cost of selling two products is 20% lesser than what is received by the sale of one product. In this example, the TR for 1 product remains the same at $5. But, the cost of selling a product is $4 thus increasing the TR by $1. The TR for 2 products is $11 rather than $10.
- Computing the new MR through the aforementioned equation, MR = $11 - $5, which is equal to $6. Therefore, the marginal revenue for the second product has changed to $6.