The marginal revenue is the increase in revenue that results from the sale of an additional unit of measure.
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Definition / explanation
Marginal revenue is the change in revenue that results from increasing the amount sold by a marginal unit. With the help of marginal revenue, it is possible to determine the optimal amount of product that will achieve maximum yield.
Marginal revenue and demand
Typically, companies use a simple formula to calculate revenue. The total revenue results from the product price multiplied by the number of products sold: Total revenue = product price * quantity
In this simple model, revenue increases linearly as the number of products increases. However, the simple model does not always describe reality, because reality actually plays out too Offer function and the Demand function an important role.
If more products are offered, there is a surplus of supply. The prices are falling. In this way, the price that could be achieved for the previously sold product can no longer be achieved for an additional product. Accordingly, the marginal revenue decreases with each product that is additionally to be sold.
The more elastic the demand functionthe greater the effect. As soon as the marginal revenue is less than the costs incurred in manufacturing the additional product, the additional sale no longer means an increase in profit.
On the contrary: the company is making losses despite its increased approach.
Importance in business administration
In business administration, the construct of marginal revenue is important to plan the right amount of production. For example, the marginal revenue can be used to decide whether to purchase an additional machine. If the costs exceed the expected increase in sales, the acquisition is not profitable.