key term - Marginal Revenue

Definition

Marginal revenue is the additional revenue a business earns by selling one more unit of a product or service. It represents the change in total revenue resulting from the sale of an additional unit, and is a crucial concept in understanding a firm's profit-maximizing decisions.

5 Must Know Facts For Your Next Test

1. Marginal revenue is the derivative of total revenue with respect to quantity, representing the slope of the total revenue curve.
2. Firms seek to produce the quantity where marginal revenue equals marginal cost in order to maximize profit.
3. Marginal revenue decreases as quantity increases due to the law of diminishing returns and the downward-sloping demand curve.
4. The relationship between marginal revenue and elasticity of demand is inverse, with more elastic demand leading to lower marginal revenue.
5. Marginal revenue plays a crucial role in the firm's decision-making process, including pricing, output, and resource allocation.

Review Questions

• Explain how marginal revenue is related to the concept of derivatives in the context of 12.4 Derivatives.
  • In the context of 12.4 Derivatives, marginal revenue is directly related to the concept of derivatives. Marginal revenue represents the derivative of total revenue with respect to quantity, which means it measures the rate of change in total revenue as the firm produces and sells one additional unit. The slope of the total revenue curve, which is the marginal revenue, can be calculated using the derivative. This relationship between marginal revenue and derivatives is essential for firms to determine the profit-maximizing level of output.
• Describe how a firm can use the concept of marginal revenue to make optimal production and pricing decisions.
  • Firms can use the concept of marginal revenue to make optimal production and pricing decisions. By understanding the relationship between marginal revenue and marginal cost, firms can determine the profit-maximizing output level where marginal revenue equals marginal cost. This allows them to set the price that will generate the highest possible profit. Additionally, firms can use marginal revenue to evaluate the impact of changes in demand, competition, or other market conditions on their revenue and profitability, and adjust their production and pricing strategies accordingly.
• Analyze how the relationship between marginal revenue and the elasticity of demand affects a firm's pricing and output decisions.
  • The relationship between marginal revenue and the elasticity of demand is crucial for a firm's pricing and output decisions. When demand is more elastic, meaning customers are more responsive to changes in price, marginal revenue will be lower for each additional unit sold. This is because the firm must lower the price to sell an additional unit, and the increase in revenue from that sale will be smaller. Conversely, when demand is less elastic, marginal revenue will be higher, as the firm can raise prices without significantly reducing the quantity demanded. Firms will seek to produce the quantity where marginal revenue equals marginal cost, but the level of this optimal output will depend on the elasticity of demand, which affects the firm's pricing power and profitability.

Related terms

Total Revenue: The total amount of money a business receives from selling its products or services.

Marginal Cost:

The additional cost incurred by a business to produce one more unit of a product or service.

Profit Maximization: The process of determining the optimal output level that will generate the highest possible profit for a business.