Marginal revenue is a cornerstone concept in economics and business decision-making. Whether you run a small business, manage a corporation, or study economic theory, grasping marginal revenue helps you optimize pricing, production, and profitability. In this guide, I break down what marginal revenue is, why it matters, and how to calculate it—with real-world examples, mathematical formulations, and practical insights.
Table of Contents
What Is Marginal Revenue?
Marginal revenue (MR) is the additional income generated from selling one more unit of a good or service. It answers a simple but powerful question: How much extra money do I make if I produce and sell one more item?
For firms operating in competitive markets, marginal revenue often equals the price of the product. However, in imperfectly competitive markets (like monopolies or oligopolies), marginal revenue declines as output increases due to downward-sloping demand curves.
The Mathematical Definition
The formal definition of marginal revenue is the derivative of total revenue (TR) with respect to quantity (Q):
MR = \frac{d(TR)}{dQ}Since total revenue is price (P) multiplied by quantity (Q), we can also express MR as:
MR = \frac{d(P \times Q)}{dQ}In a perfectly competitive market, price remains constant regardless of quantity sold, so MR simplifies to:
MR = PBut in markets where price decreases with higher output (like monopolies), MR becomes:
MR = P + Q \times \frac{dP}{dQ}This shows that marginal revenue is influenced by both the current price and the rate at which price changes with quantity.
Why Marginal Revenue Matters
Understanding marginal revenue helps businesses make critical decisions:
- Profit Maximization – Firms maximize profit where marginal revenue equals marginal cost (MR = MC).
- Pricing Strategy – If MR > MC, producing more increases profit. If MR < MC, reducing output is better.
- Market Power Assessment – A declining MR curve indicates pricing control (e.g., monopolies).
Example: Calculating Marginal Revenue
Suppose I run a coffee shop, and my current sales data looks like this:
| Quantity (Q) | Price (P) | Total Revenue (TR = P × Q) | Marginal Revenue (MR) |
|---|---|---|---|
| 10 | $5 | $50 | – |
| 11 | $4.90 | $53.90 | $3.90 |
| 12 | $4.80 | $57.60 | $3.70 |
Here, MR is calculated as the change in TR divided by the change in Q:
MR = \frac{\Delta TR}{\Delta Q}For Q = 11:
MR = \frac{53.90 - 50}{11 - 10} = 3.90For Q = 12:
MR = \frac{57.60 - 53.90}{12 - 11} = 3.70Notice how MR decreases as quantity increases—this happens because lowering prices to sell more reduces per-unit revenue.
Marginal Revenue in Different Market Structures
1. Perfect Competition
In a perfectly competitive market, firms are price takers. They sell as much as they want at the market price, so MR = P.
Example: A wheat farmer sells bushels at $10 each. Each additional bushel sold adds exactly $10 to revenue.
MR = P = \$102. Monopoly
A monopolist faces the entire market demand curve. To sell more, they must lower prices, reducing MR.
Example: A pharmaceutical company with a patented drug sets prices based on demand.
| Q | P | TR | MR |
|---|---|---|---|
| 1 | $100 | $100 | $100 |
| 2 | $90 | $180 | $80 |
| 3 | $80 | $240 | $60 |
Here, MR is less than price because price must drop to increase sales.
3. Monopolistic Competition & Oligopoly
Firms in these markets have some pricing power but face competition. MR declines but not as steeply as in a monopoly.
Marginal Revenue vs. Marginal Cost
Profit maximization occurs where:
MR = MCIf MR > MC, producing more increases profit.
If MR < MC, producing less improves profitability.
Example:
Suppose my bakery’s MR for the next cupcake is $4, and MC is $3. Since MR > MC, baking and selling that cupcake increases profit by $1.
Practical Applications
- Dynamic Pricing – Airlines and ride-sharing apps adjust prices based on demand, directly affecting MR.
- Discount Strategies – Bulk discounts reduce MR per unit but may increase total revenue.
- Production Scaling – Manufacturers compare MR and MC to decide optimal output levels.
Common Misconceptions
- “MR is always equal to price.” Only true in perfect competition.
- “Increasing production always raises profit.” Not if MC exceeds MR.
- “MR is the same as average revenue.” Average revenue is TR/Q, while MR is ΔTR/ΔQ.
Conclusion
Marginal revenue is a vital tool for pricing, production, and profit optimization. By understanding how MR interacts with costs and market conditions, I can make better business decisions. Whether in a competitive or monopolistic setting, calculating and applying MR ensures efficient resource allocation and maximizes financial outcomes.
