Marginal Profit
Candlefocus EditorWhen looking more closely at what marginal profit is, it's helpful to consider the underlying components of the concept. Marginal revenue (MR) is the additional revenue that is generated from the sale of an additional unit. It is equal to the total revenue minus the contribution from the sale of previous units. Marginal cost (MC) is the additional cost associated with producing and distributing that extra unit of a product.
The formula for calculating marginal profit is MR minus MC. For example, if a business is adding an extra product unit to its production to generate an additional $30 in revenue and incurs an additional cost of $20 to produce it, the marginal profit is $10. This same concept can be applied to services. If a business wants to serve an additional customer and sells an additional service at $80, and the cost of providing that service is $60, the marginal profit is $20.
Marginal profit analysis can help guide managerial decision making and inform various courses of action that could be taken. For example, if marginal profit exceeds the opportunity costs associated with the production of that extra unit of a product, the manager may decide to increase production accordingly. However, if marginal profit falls below the opportunity costs, the manager may choose to reduce production to increase profitability.
Marginal profit should not be confused with average profit, which is the average amount of profit generated from the sale of a number of units. While marginal profit is the measure of additional income resulting from the production or sale of an additional unit, average profit is the measure of average income generated from the sale of multiple units.
In summary, marginal profit is the additional income generated from the sale of an additional unit of a product or service. It is calculated by taking the difference between marginal revenue and marginal cost. Marginal profit analysis can be used to help determine whether or not to increase or decrease the level of output for increased profitability. It should not be confused with average profit, which measures average income generated from the sale of multiple units.