How to Find Marginal Revenue
According to basic economic principles, if a company lowers the price of its products, then that company can sell more products. However, this will generate less profit for each additional item sold. Marginal revenue is the increase in revenue from the sale of an additional unit of output. Marginal revenue can be calculated using a simple formula: Marginal revenue = (change in total revenue)/(change in units sold).
Using the Formula to Calculate Marginal Revenue
Find the number of products sold. To calculate the marginal revenue, it is necessary to find the values (exact and estimated) of several quantities. First you need to find the number of goods sold, namely one type of product in the company’s product range.
Consider an example. A certain company sells three types of drinks: grape, orange and apple. In the 1st quarter of this year, the company sold 100 cans of grape juice, 200 of orange and 50 of apple. Find the marginal revenue for the orange drink.
Please note that in order to obtain the exact values of the quantities you need (in this case, the number of goods sold), you need access to financial documents or other company records.
Find the total revenue received from the sale of a particular type of product. If you know the unit price of an item sold, you can easily find the total revenue by multiplying the quantity sold by the unit price.
In our example, the company sells an orange drink for $2 per can. Therefore, the total revenue from the sale of an orange drink is: 200 x 2 = $400.
The exact value of total revenue can be found in the income statement. Depending on the size of the company and the number of products sold in the reporting, you will most likely find revenue values not for a specific type of product, but for a category of products.
Determine the unit price that must be charged in order to sell an additional unit of output. As a rule, such information is given in tasks. In real life, analysts have been trying to determine such a price for a long time and with difficulty.
In our example, the company lowers the price of an orange drink from $2 to $1.95. For this price, the company can sell an additional unit of orange drink, bringing the total number of items sold to 201.
Find the total revenue from the sale of goods at the new (presumably lower) price. To do this, multiply the quantity of goods sold by the price per unit.
In our example, the total revenue from the sale of 201 cans of orange drink at $1.95 per can is: 201 x 1.95 = $391.95.
Divide the change in total revenue by the change in sales to find marginal revenue. In our example, the change in quantity sold is 201 – 200 = 1, so here, to calculate marginal revenue, simply subtract the old value of total revenue from the new value.
In our example, subtract the total revenue from selling the $2 item (per item) from the revenue from selling the item at $1.95 (per item): 391.95 – 400 = – $8.05.
Since the change in sales is 1 in our example, here you do not divide the change in total revenue by the change in sales. However, in a situation where a price reduction results in the sale of several (rather than one) units of a product, you will need to divide the change in total revenue by the change in the number of products sold.
Using Marginal Revenue Value
Prices for products should be such as to provide the greatest revenue with an ideal ratio of price and quantity of products sold. If a change in unit price results in a negative marginal revenue, then the company incurs a loss, even if the price reduction allows more products to be sold. The company will make additional profit if it raises the price and sells fewer products.
In our example, marginal revenue is -$8.05. This means that by reducing the price and selling an additional unit of production, the company incurs losses. Most likely, in real life, the company will abandon plans to reduce the price.
Compare marginal cost and marginal revenue to determine a company’s profitability. For companies with an ideal price-to-quantity ratio, marginal revenue equals marginal cost. Following this logic, the greater the difference between total costs and total revenue, the more profitable the company.
Marginal cost is the ratio of the change in the cost of producing an additional unit of