Marginal revenue is the increase in total revenue when one more unit of product is sold. Since this unit is sold at the market price, for a company in free competition the marginal revenue is equal to the price.
It can be kept constant, but the normal thing is that it follows the law of diminishing returns and the more units produced, the lower the marginal revenue. It will be profitable for a firm to produce more units even though marginal revenue is decreasing until it equals marginal cost. Marginal revenue is calculated by dividing the change in total revenue by the number of additional units.
Marginal revenue example
A company that manufactures dolls has a total income of 0 euros when no dolls are produced. However, the income is seen from the production of your first doll: if it costs 15 euros, the marginal income would be:
MI = (15 euros in total revenue / 1 unit of product) = 15 euros
If the income of the second doll is 10 euros, the marginal income obtained through the production of this second doll would be:
IM = (15 + 10) – 15 euros / 1 additional unit) = 10 euros / 1 additional unit = 10 euros
Using marginal revenue, the firm compares the amount that each additional unit adds to both total revenue and total cost. Likewise, if the revenue of each additional unit is greater than its marginal cost (which measures the rate of change in cost divided by the change in production), the company must produce that unit or else be they will reduce your profits or increase your losses.
Generally, in the initial stages of production, marginal revenue is usually greater than marginal cost and, therefore, it is profitable to continue producing within the same dynamics. However, in later phases, when production is relatively high, marginal costs may grow more than marginal revenues, so the organization should avoid production in this line.
When seeking to maximize the company’s profits from a competitive perspective, as in other market structures, the marginal approach is used, so that in the short term profits are optimized or losses are minimized, producing the level of product in which marginal revenue equals marginal cost.
Finally, it can be said that the relationship between marginal costs and marginal income is direct, since there is an increase in production in one unit, an immediate increase in the cost of production is generated. Likewise, this increase in a productive unit also generates a growth in marginal income, which will be favorable until reaching the point of equilibrium. Once this limit is crossed, the production of an additional unit would generate a decrease in income due to the growth of the cost of that additional production.