Marginal Revenue (MR) is an important concept in economics and managerial decision-making, referring to the change in revenue that occurs when one additional unit of a product is produced and sold. MR helps companies analyze and monitor the revenue generated for each additional unit sold, and helps evaluate the benefits of production.
At each additional unit of production, marginal revenue numbers are often graphed as a downward sloping line, indicating the reality of supply and demand: to drive additional sales, a company usually has to reduce the price of their product. If a business chooses to reduce the price of the product, it will increase their number of sales and its total revenue but, at the same time, decrease its marginal revenue – the extra income from selling one more unit.
In order to maximize profits, companies should produce up to the point where marginal cost (the cost associated with producing and selling an additional unit) equals marginal revenue. For example, if the cost of producing a product is £5 and the sale of one more unit yields £5 in revenue, then it is cash neutral, with no changes to current profits. On the other hand, should marginal cost be higher than marginal revenue (i.e., producing a unit of the product costs £7 and generates £5 in revenue), the company will experience a negative return, with the sale of the product costing the company £2 and should thus decide to stop producing more units of the product.
For a business, understanding the relationship between marginal cost and marginal revenue is key to making cost-effective decisions. By analyzing these figures and understanding the additional expense associated with each unit of production and the profit generated by each additional sale, businesses can analyze their profits and losses in detail, enabling them to make more informed entrepreneurial decisions. Without considering the marginal revenue and marginal cost, companies are likely to be operating at a loss, regardless of their total sales and total revenue.
At each additional unit of production, marginal revenue numbers are often graphed as a downward sloping line, indicating the reality of supply and demand: to drive additional sales, a company usually has to reduce the price of their product. If a business chooses to reduce the price of the product, it will increase their number of sales and its total revenue but, at the same time, decrease its marginal revenue – the extra income from selling one more unit.
In order to maximize profits, companies should produce up to the point where marginal cost (the cost associated with producing and selling an additional unit) equals marginal revenue. For example, if the cost of producing a product is £5 and the sale of one more unit yields £5 in revenue, then it is cash neutral, with no changes to current profits. On the other hand, should marginal cost be higher than marginal revenue (i.e., producing a unit of the product costs £7 and generates £5 in revenue), the company will experience a negative return, with the sale of the product costing the company £2 and should thus decide to stop producing more units of the product.
For a business, understanding the relationship between marginal cost and marginal revenue is key to making cost-effective decisions. By analyzing these figures and understanding the additional expense associated with each unit of production and the profit generated by each additional sale, businesses can analyze their profits and losses in detail, enabling them to make more informed entrepreneurial decisions. Without considering the marginal revenue and marginal cost, companies are likely to be operating at a loss, regardless of their total sales and total revenue.