Marginal revenue is described as an economic measure that is most commonly used to determine the revenue that an organization can generate from the sale of one single additional unit or further good.
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Understanding the concept of marginal revenue
Marginal revenue has a profound relationship with marginal cost. If the marginal revenue is more than the marginal cost, it means that the company is showing a profit, and it should increase its production.
How to calculate marginal revenue is considered a critical theory for every business as it helps it to understand that there is a point when the business will stop making a profit. It identifies the exact unit when the business entity should stop its production of further products so that it is still in the green.
There comes a time when both marginal revenue and marginal cost are equal, and this is known as profit maximization. After this point, there is simply no chance that the organization can make money. It is in its interest to stop the process of production.
How to calculate marginal revenue is a way to ensure that the business is not losing money.
It is a fact that when the marginal revenue of a product is less than its marginal cost, it means that the business is going to show a net loss. In simple terms, the cost of an additional unit is more than the amount the organization is receiving from that unit. The time when marginal revenue is less than the marginal cost, the company should decrease its production.
Marginal revenue in the monopoly market and competitive market
In a market that is considered perfectly competitive, the sales cannot have an impact on the price in the industry. The additional earnings earned by the sale of an extra unit is equal to the price it charges its buyer. The fact is that in a perfectly competitive market, the price of every unit sold will always fetch the same price irrespective of the number of units the company sells.
In a monopoly market, the entire sales of the industry are affected. If a company wants to increase its sales by 1 unit, it will have to drop the product price of all the units it sells. In such cases, the marginal revenue will be less than the price it has charged the buyer.
Remember in a monopoly market the marginal revenue is determined by the demand and supply whereas in a competitive market it is the marginal cost that determines the marginal revenue of the units,
How to calculate marginal revenue
Marginal revenue is calculated with the help of the formula given below-
Marginal Revenue (MR) = Change in Revenue / Change in Quantity
The formula, as you can see, has two main components change in revenue as well as a change in quantity. The change in revenue is described as the difference between the new and old revenues or simply as
Change in revenue = Total revenue – Old revenue
The change in quantity is described as the difference between the new and old quantities or simply as
Change in quantity = Total quantity – Old quantity
You need to calculate both the changes to know about the marginal revenue
Examples of marginal revenue
ABC Ltd manufactures 1000 laptop units every month and sells it at 1400 dollars per unit. The company has increased its production to 1100 units at the same price and has now sold all the units at 1595000 dollars. We know how to calculate marginal revenue by a simple formula
Marginal Revenue (MR) = Change in Revenue / Change in Quantity
The change in revenue in this instance for how to calculate marginal revenue is
Change in revenue = Total revenue – Old revenue
Change in revenue = 1595000 – (1000 * 1400)
Change in revenue = 1595000 – 1400000
Change in revenue = 195000 dollars
Similarly the change in quantity in this instance for how to calculate marginal revenue
Change in quantity = Total quantity – Old quantity
Change in quantity = 1100 – 1000
Change in quantity = 100 units
Thus if you are looking for how to calculate marginal revenue then
Marginal Revenue (MR) = Change in Revenue / Change in Quantity
Marginal Revenue (MR) = 195000 / 100
Marginal Revenue (MR) = 1950 dollars
The marginal revenue of every additional unit is 1950 dollars.
XYZ Company has sold its products at 100 dollars per unit. If the first additional unit is sold at suppose 110 dollars or even 90 dollars, then its marginal revenue will be 110 dollars or 90 dollars, respectively.
Tom sells 10 gardening tools every day at 100 dollars per unit or a total price of 1000 dollars. From now onwards, he wants to sell 15 tools at 99 dollars each. But first, he wants to know the marginal revenue of the additional unit he will be selling.
Tom is looking for how to calculate marginal revenue, and he has to use this formula
Marginal Revenue (MR) = Change in Revenue / Change in Quantity
The change in revenue in this instance for how to calculate marginal revenue
Change in revenue = Total revenue – Old revenue
Change in revenue = 11 * 99 – 1000
Change in revenue = 1089 -1000
Change in revenue = 89 dollars
Similarly the change in quantity in this instance for how to calculate marginal revenue
Change in quantity = Total quantity – Old quantity
Change in quantity = 11 – 10
Change in quantity = 1 units
Thus if you are looking for how to calculate marginal revenue for one additional unit, then
Marginal Revenue (MR) = Change in Revenue / Change in Quantity
Marginal Revenue (MR) = 89 / 1
Marginal Revenue (MR) = 89 dollars
The marginal revenue of every additional unit is 89 dollars.
The relevance of marginal revenue
The relevance of marginal revenue is as follows-
1. Analyzing consumer demand
An organization must analyze the demand for various products it deals with. Miscalculation of the demand factor in the consumer market can result in a product shortage. This means a loss of sales. The misjudgment can also lead to excess in production, and this will mean excess in the manufacturing cost. Both situations mean a loss for the firm and that is why it becomes imperative to calculate the marginal revenue and know the point where it should halt the production
2. Plan production schedules
After analyzing the demand factor in the consumer market, the marginal revenue is used by the management of an organization to plan its schedule for production
3. Setting product prices
Most organizations use marginal revenue to set the price of their products. This helps to create a change in the demand factor because high prices will automatically minimize the demand for that product. Fewer supply increases demand and automatically the willingness to pay a high price for a product by the consumer.
This is why most organizations adjust the price and output so that they can boost their profitability.
Conclusion
The concept of marginal revenue has proved a great help to organizations. It has been able to determine what it considers the ideal level of production to increase their profit margins.
