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Calculating marginal revenue is an essential concept in the field of economics, particularly for businesses. Marginal revenue represents the change in total revenue generated from the sale of an additional unit of a product or service. It helps companies determine the profitability of producing and selling additional units and allows them to make informed decisions regarding their pricing and production strategies. By understanding how to calculate marginal revenue, businesses can optimize their revenue generation and make strategic choices to maximize their profits. In this article, we will delve into the step-by-step process of calculating marginal revenue and explore its significance for businesses.
This article was co-written by Alex Kwan. Alex Kwan is a Certified Public Accountant (CPA) and CEO of Flex Tax and Consulting Group in the San Francisco Bay Area. He is also the vice president of one of the top five private companies. With more than ten years of experience as a certified public accountant, he specializes in providing customer-focused accounting and consulting services, research & development tax services, and small businesses.
There are 8 references cited in this article that you can see at the bottom of the page.
This article has been viewed 16,166 times.
According to a basic tenet of economics, if a company reduces the price of a product it sells, it will sell more products, but make less money for each product. This “additional money” — the amount of revenue that comes from selling one more product — is marginal revenue.
Steps
Calculate marginal revenue
- total revenue=Current price of each productxCurrent number of products sold{displaystyle {text{Total sales}}={begin{aligned}{text{Current price per item}}x {text{Current number of products sold}}end{aligned}}}
- Replacement revenue=(Replacement price)(Number of products sold for replacement){displaystyle {text{Alternative sales}}=({text{Replacement price}})({text{Alternative sales}})}
- Marginal costs=Replacement revenue−Initial revenueNumber of products sold for replacement−Current number of products sold{displaystyle {text{Marginal cost}}={frac {{text{Replacement revenue}}-{text{Initial revenue}}}{{text{Replacement sales}}-{text {Current number of products sold}}}}} .
- In other words, marginal revenue is the change in revenue for each additional product sold.
- total revenue=($25)(500)=$12,500{displaystyle {text{Total sales}}=($25)(500)=$12,500}
- The company decided to reduce the selling price to $24 to sell 530 T-shirts.
- Replacement revenue=($24)(530)=$12.720{displaystyle {text{Alternative sales}}=($24)(530)=$12,720}
- Marginal revenue=12720−12500530−500=22030=$7,33{displaystyle {text{Marginal Revenue}}={frac {12720-12500}{530-500}}={frac {220}{30}}=$7.33}
Marginal Revenue Analysis
- Note, marginal revenue is only useful when analyzing a product. Some reports only list data for each product group.
- Marginal costs=Replacement cost of production−Current production costNumber of products sold for replacement−Current number of products sold{displaystyle {text{Marginal cost}}={frac {{text{Replacement cost of production}}-{text{Current cost of production}}}{{text{sold substitutes} }-{text{Current number of products sold}}}}} .
- For example, Kim’s Soda produces 200 cans of soda at a cost of $50. Kim can spend $60 to produce 225 cans. Marginal costs=60−50225−200=$0,40{displaystyle {text{Marginal cost}}={frac {60-50}{225-200}}=$0.40} . Kim’s soda will only execute this plan if its marginal revenue is equal to or greater than $0.40.
Understanding different market structures
- For example, Kim, the soda company in the example above, now has to compete with hundreds of other soda manufacturers. The price of each soda is $0.50 — if the price is lower, Kim’s will lose, and if it is higher, customers will choose to buy other products. Marginal revenue is always $0.50 because Kim cannot sell at any other price.
- For example, Kim reduced the selling price of 1 can of soda from $1 to $0.85. They may still get extra revenue, but in an oligopolistic market the customer will still buy the competitor’s soda at a higher price.
- Kim has become a major soda maker, and now shares the market with Linda and Andy, two other soda makers. These three firms agree to sell soda at the same price, so that the marginal revenue for each additional can of soda won’t change, no matter what price they choose. If Jeff started a small firm to sell soda at a lower price that competed with their inflated prices, the three firms could reduce the price of the product so low that Jeff was forced to shut down. These firms accept a temporary decrease in marginal revenue because they can raise prices again after they have eliminated Jeff from the playing field.
This article was co-written by Alex Kwan. Alex Kwan is a Certified Public Accountant (CPA) and CEO of Flex Tax and Consulting Group in the San Francisco Bay Area. He is also the vice president of one of the top five private companies. With more than ten years of experience as a certified public accountant, he specializes in providing customer-focused accounting and consulting services, research & development tax services, and small businesses.
There are 8 references cited in this article that you can see at the bottom of the page.
This article has been viewed 16,166 times.
According to a basic tenet of economics, if a company reduces the price of a product it sells, it will sell more products, but make less money for each product. This “additional money” — the amount of revenue that comes from selling one more product — is marginal revenue.
In conclusion, calculating marginal revenue is an essential concept in determining the additional revenue generated by selling one additional unit of a product or service. By understanding the formula and method to calculate marginal revenue, businesses can make informed decisions about pricing, production levels, and overall revenue optimization. It is important to remember that marginal revenue is influenced by factors such as elasticity of demand, market competition, and cost structure. Therefore, businesses should regularly calculate and monitor marginal revenue to ensure they are maximizing their profitability and making strategic decisions for future growth.
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