How to Determine Marginal Revenue From Price & Quantity
Marginal revenue is the amount of revenue that is expected to be received from additional sales volume. Marginal revenue is important for management because total corporate profit increases as long as marginal revenue exceeds marginal cost. Management can calculate marginal revenue by multiplying the sales quantity by the average sales price per unit. However, due to diminishing marginal utility and the downward sloping demand curve, management often must reduce price to induce additional sales.
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Instructions
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Estimate the average sales price per unit. For some businesses, estimating the average sales price is relatively simple. For example, a soda company probably knows the price it can charge retailers for its cases of soda at a given level of demand. However, to maximize its profit, it may seek increase its sales volume. All else being equal, to stimulate additional demand, it likely will have to reduce its sales price. Thus, management experience and professional judgment are important in selecting the optimal price point and sales volume.
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Obtain marginal sales quantity. This basically is the unit volume of additional sales transactions. To estimate the amount of marginal sales volume at various price points, management should draw upon its experience and business judgment. Under the economic concept of diminishing marginal utility, consumers derive less and less pleasure or functionality from more and more units purchased. Thus, a lower marginal price may not automatically result in predictable increases in marginal sales volume.
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Multiply marginal sales quantity by the estimated average sales price per unit. To determine marginal revenue, simply multiply the expected marginal sales quantity times the average sales price per unit. For example, if a company can expect to sell 100,000 bottles of soda at $2 per unit, or 150,000 at $1.75 per unit, or 200,000 at $1.50 per unit, it can calculate its marginal revenue at each price point and level of demand. This, coupled with marginal cost information, allows management to evaluate its expected profit or loss at each point on the demand curve.
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