When it comes to revenue and profit, growth is rarely linear.
Part of that comes down to external factors like market demand and prevailing economic conditions.
However, especially where physical production is concerned, producing and selling one additional unit doesn’t always translate to additional profit.
The difference in income a business earns from selling one additional unit is called marginal revenue. Understanding marginal revenue at each production point is critical for identifying the right level of output.
In this article, we’ll explore what marginal revenue is, how to calculate it, and how you can apply it in practice to improve profitability.
What is marginal revenue?
Marginal revenue is the extra income a business earns from selling one additional unit of a product or service. It’s calculated by dividing the change in total revenue by the change in quantity sold and helps businesses assess whether producing and selling more will increase profits.
Understanding marginal revenue
Marginal revenue is a critical measurement for identifying the profit-maximizing point, where the income from producing and selling an additional unit is equal to the marginal cost of making it. It shows whether producing and selling an extra unit will add to or reduce profit, helping guide decisions on pricing and production levels.
Marginal revenue has an important relationship with demand.
In perfectly competitive markets, marginal revenue is equal to the market price. But not all markets are perfectly competitive.
In imperfect markets like monopolies, marginal revenue often falls below the demand curve, because each additional sale may require a price reduction, lowering revenue but not necessarily reducing costs.
Difference between marginal revenue and total revenue
Total revenue is the overall income your business generates from all sales, while marginal revenue outlines the incremental gain from selling one more unit.
While total revenue gives you a broad view of performance, marginal revenue helps you determine how changes in production or pricing can impact profitability.
How to calculate marginal revenue
To measure how much additional revenue each new unit contributes, businesses use the marginal revenue formula. It shows the change in total revenue divided by the change in quantity sold.
Formula for marginal revenue
First, you need to calculate two starting figures:
- Change in revenue (Current total revenue - Previous total revenue)
- Change in number of units sold (Current quantity - Previous quantity)
Then, you apply this formula:
Step-by-step calculation process
Here’s a quick play-by-play on calculating marginal revenue:
- Define the comparison periods or output levels you want to evaluate
- Gather your total revenue for each period or output level
- Gather the corresponding quantities sold for each period or output level
- Calculate the change in total revenue (Current total revenue - Previous total revenue)
- Calculate the change in quantity (Current quantity - Previous quantity)
- Apply the marginal revenue formula (Change in revenue / Change in number of units sold)
- Interpret the result relative to marginal cost to decide whether producing or selling more will increase profit
Common pitfalls in calculating marginal revenue
As we’ve outlined above, calculating marginal revenue is a relatively straightforward process, but there are a few common pitfalls that can skew your results.
Here are the main ones you’ll want to avoid:
- Using average revenue instead of marginal revenue: Price or ARPU is not marginal revenue unless revenue rises one-for-one with quantity. Always use the change in totals divided by the change in units.
- Mixing time periods or segments: It's important to keep the same product mix, time window, and channel to ensure comparisons are relevant.
- Large quantity jumps: Using large changes in quantity hides the “at the margin” effect. Use the smallest practical change, ideally one unit.
- Not accounting for discounts, returns, or credits: Marginal revenue needs to be calculated using net revenue, after accounting for discounts, refunds, chargebacks, and taxes you remit.
- Price changes applied to all units: If you cut the price on every unit to sell a few more, the drop in revenue on existing units must be reflected in the change in total revenue.
- Not considering bundling effects: Some new unit sales cannibalize other products or depend on bundle pricing, which requires adjustments to avoid overstating marginal revenue.
Example of marginal revenue
Marginal revenue can behave very differently across industries, owing to factors like demand elasticity and the prevalence of discounts in the market.
Manufacturing
Say a car manufacturer sells 1,000 vehicles at a price of $40,000 each, equating to a total of $40m in revenue.
The following month, it sells 1,050 vehicles, but offers small deal discounts to do so, earning $41,475,000 in total revenue.
Here’s what their marginal revenue calculation looks like:
- Find the change in total revenue: 41,475,000 - 40,000,000 = 1,475,000
- Find the change in quantity: 1,050 - 1,000 = 50
- Calculate marginal revenue: 1,475,000 / 50 = 29,500
The marginal revenue is $29,500 per vehicle. That’s much lower than the original $40,000 sale price, showing how discounts can quickly erode per-unit revenue even as total sales rise.
SaaS
Imagine a software company with 1,000 users that pay $100 per month, generating $100,000 in monthly recurring revenue (MRR).
It runs a marketing campaign and gains 100 new users, bringing total MRR to $110,000.
Here’s how this SaaS business will calculate marginal revenue:
- Find the change in total revenue: 110,000 - 100,000 = 10,000
- Find the change in quantity: 1,100 - 1,000 = 100
- Calculate marginal revenue: 10,000 / 100 = 100
The marginal revenue is $100 per new user, exactly matching the subscription price. Because the cost of serving new users is minimal, SaaS businesses often enjoy stable or even constant marginal revenue.
Hospitality
Consider a hotel that earns $20,000 a night from 100 occupied rooms (a per-room rate of $200 per night).
To attract more guests, it lowers prices to $190 and fills 110 rooms, earning $20,900.
Its marginal revenue calculation will look like this:
- Find the change in total revenue: 20,900 - 20,000 = 900
- Find the change in quantity: 110 - 100 = 10
- Calculate marginal revenue: 900 / 10 = 90
The marginal revenue is $90 per room, far below the room rate. While total revenue increased, the reduced rate lowered profit per booking. This shows how pricing decisions directly affect marginal revenue in hospitality.
How marginal revenue works
Marginal revenue shows how changes in sales volume affect overall revenue.
When a business sells more units, total revenue typically rises, but not always at the same rate.
Early on, each additional sale might add roughly the same amount of revenue. But, eventually, increasing sales generally requires lowering prices, which means marginal revenue declines.
The relationship between sales volume and revenue generation
Where demand is strong, selling more units tends to increase revenue at a steady rate.
Change occurs when markets become saturated and/or price cuts are required to stimulate additional demand. Here, additional unit sales contribute less and less to revenue.
This explains why the pattern seen in most real-world markets is that marginal revenue typically falls as output increases.
Factors affecting marginal revenue in different industries
The shape of the marginal revenue curve can vary significantly by industry.
In competitive sectors like agriculture or commodity manufacturing, marginal revenue curves are often flat, as prices are set by the market.
In contrast, industries that have differentiated products (such as hospitality, technology, and luxury goods) tend to see marginal revenue fall more sharply, as price reductions are more commonly required to attract more buyers.
Impact of pricing strategies on marginal revenue
Pricing also plays an important role in determining marginal revenue.
Discounts, dynamic pricing, and bundling can all change how much extra income each sale brings in.
For instance, a promotional discount might boost total revenue in the short term, but it will also lower marginal revenue per unit. Conversely, a premium pricing model may keep marginal revenue high, but it can also limit total sales volume.
Finding the right balance between price and quantity helps businesses maximize profit while maintaining demand.
Marginal revenue vs. marginal cost
Marginal revenue is the additional income a business earns from selling one extra unit of a product or service. Marginal cost, on the other hand, is the additional expense incurred from producing that extra unit, including materials, labour, and overhead.
Profitability depends on how these two measures align.
If marginal revenue is higher than marginal costs, producing and selling more units increases profit, and vice versa.
The general rule here is that as output increases, marginal costs typically rise, and marginal revenue falls.
The profit-maximizing point occurs where marginal revenue equals marginal cost. Beyond this point, producing more only reduces profit.
Understanding marginal revenue with BILL
Understanding marginal revenue is essential for identifying how each additional unit sold contributes to overall revenue and profit.
By tracking marginal revenue alongside marginal cost, companies can fine-tune output levels, evaluate the impact of discounts or pricing changes, and allocate resources where they generate the strongest return. This insight enables smarter growth,
whether that means scaling production, adjusting prices, or improving profitability on existing sales.
With BILL, finance teams can put these insights into action by leveraging:
- Centralized financial data and reporting
- Automated workflows
- Clearer visibility into performance
Frequently asked questions
Why is marginal revenue important in economics?
Marginal revenue helps businesses and economists understand how changes in sales volume impact total revenue and profitability. It’s essential for:
- Determining the optimal level of production
- Guiding pricing decisions
- Identifying when producing more will no longer increase profit
What factors can affect marginal revenue?
The most common factors impacting marginal revenue are:
- Pricing strategies
- Market competition
- Consumer demand
- Product differentiation
- Elasticity of demand
- Temporal factors like discounts and seasonal trends
