Marginal revenue is the change in total revenue that results from selling one additional unit of output. If a company earns $10,000 from selling 100 units and $10,080 from selling 101, the marginal revenue of the 101st unit is $80. The concept comes from economics but is used widely in managerial accounting, pricing and production planning, because it tells managers whether expanding sales will add to or subtract from profit.
Marginal revenue is always considered together with marginal cost, the extra cost of producing one more unit. A business maximizes profit at the level of output where marginal revenue equals marginal cost. Below that point, each extra unit adds more to revenue than to cost; above it, each extra unit loses money.
How marginal revenue is calculated
The general formula is:
- is marginal revenue.
- is the change in total revenue.
- is the change in quantity sold.
Total revenue is price times quantity. If a firm can sell any quantity at the same price, marginal revenue simply equals the price. But if it must cut its price to sell more, which is the usual case, marginal revenue is lower than the price, because the price cut applies to all the units that could have been sold at the higher price.
Worked example
A software company sells annual licences. At a price of $50 it sells 10 licences a day; to sell 11 it must cut the price to $48 for everyone.
| Price | Quantity | Total revenue | Marginal revenue |
|---|---|---|---|
| $50 | 10 | $500 | - |
| $48 | 11 | $528 | $28 |
| $46 | 12 | $552 | $24 |
| $44 | 13 | $572 | $20 |
The 11th licence sells for $48, but marginal revenue is only $28, because the first 10 customers now each pay $2 less. If the marginal cost of serving another customer, such as support and hosting, is $22, the company should sell 12 licences (marginal revenue $24 is above $22) but not 13 (marginal revenue $20 is below $22).
Marginal revenue in different markets
In perfect competition, each firm is a price taker: it can sell as much as it wants at the market price, so marginal revenue equals price and the demand curve it faces is flat. In a monopoly or any market where a firm has pricing power, the firm faces a downward-sloping demand curve and marginal revenue falls faster than price. The link to price elasticity is direct: when demand is elastic, cutting price raises total revenue, so marginal revenue is positive; when demand is inelastic, cutting price lowers total revenue, so marginal revenue is negative. A profit-maximizing firm with pricing power therefore never operates where demand is inelastic.
Uses in accounting and decision-making
Accountants rarely calculate marginal revenue unit by unit. In practice, they use the closely related idea of incremental revenue, the extra revenue from a decision such as accepting a special order, adding a product line or running a promotion, and compare it with the incremental cost. Cost-volume-profit analysis applies similar thinking with a constant price, using the contribution margin per unit. Marginal revenue analysis is also used in setting volume discounts, in airline and hotel revenue management, and in digital businesses, where the marginal cost of serving one more customer can be close to zero.
A common mistake is to confuse marginal revenue with average revenue (total revenue divided by units), which equals the price. Another is to ignore the effect of a price cut on existing customers, which is often the largest component of the change. Marginal revenue also assumes other things are equal; in real markets, competitors respond to price changes, which can shift the demand curve itself and make simple estimates of profit-maximizing output unreliable.