What Is a Marginal Revenue Function?

marginal-revenue-function Credit: Martin Barraud/Caiaimage/Getty Images

The marginal revenue function in economics refers to the increase in revenue resulting from the sale of one additional unit of output. Marginal revenue is calculated by dividing the change in revenue by the change in output. While the marginal revenue function can remain constant over a specific level of output, it follows the law of diminishing returns. As a result, marginal revenue tapers off as output increases.

The market revenue function is also defined as the revenue obtained from the last unit of output sold. It is therefore aligned with the demand curve, because it shows how much a firm has to lower a price in order to sell one more unit of output.

The marginal revenue function plays a crucial role in forecasting a profit maximization price. A competitive business reaches this point when marginal revenue, the additional revenue procured from producing one more unit of output, equals marginal cost, the extra cost of producing the additional unit. If the two are not equal, the business can increase profits by producing more or less output.

The relationship between marginal revenue and output depends on the market structure. For competitive businesses, marginal revenue is equal to average revenue and price. These variables, which are constant, are equal because competitive businesses sell their output at market price.