Formula for Calculating Marginal Revenue

Marginal revenue is a useful tool companies use to determine how to price their products and services, and here's how it's calculated.

Sep 4, 2015 at 9:33AM

Marginal revenue refers to the amount of additional revenue a company can expect to receive by selling one more product, or unit. For this reason, it is often referred to as "unit revenue."

Calculating marginal revenue can be more complicated than it seems, depending on the type of market for the particular product or service. For most products, to generate additional demand (and sell more products), the price needs to drop -- which can affect the additional amount of revenue per product a company can expect to produce.

Marginal revenue in a competitive market
If there are many firms that offer a substantially identical product at roughly the same price, we can say that the market is "competitive". Real-world examples of competitive markets include agricultural products and commodities.

In a competitive market, marginal revenue is equal to the price of the product. For example, if a farmer can sell tomatoes for $10 per bucket, the marginal revenue from producing an additional bucket is $10.

Marginal revenue in a non-competitive market
Most goods and services sold are not competitive markets in the economic sense, meaning that one company or a handful of companies can control the price of the goods they sell. For example, Apple is certainly in competition with many other mobile phone manufacturers, but it is the only company that makes the iPhone, so Apple can control its price.

Thanks to the laws of supply and demand, if Apple increases the price for the iPhone, it will become too expensive for some people and demand will go down. Conversely, if Apple lowers the price, demand for the iPhone would increase and the company would sell more phones.

So, the basic formula for calculating marginal revenue is

Marginal Rev Formula

As a simplified example, let's say that Apple can sell 10 iPhones if it charges $700. If Apple decides to lower the price to $680, it can sell 11. In other words, by selling 10 iPhones, Apple would generate $7,000 in revenue. And selling 11 phones would produce revenue of $7,480 -- making the marginal revenue of the 11th phone $480.

Marginal Rev Example

In most real-world situations, marginal revenue is less than the price of the product or service, and decreases as more products are sold. The challenge these businesses face is to determine how much they need to charge for a product in order to maximize profit, for which they use something called the marginal revenue curve. For example, if it costs Apple $500 to make an iPhone, it doesn't make sense for the company to sell more phones if it makes the marginal revenue fall below that amount.

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