What's the Difference Between Marginal Cost and Marginal Revenue

What Is Marginal Cost?

You can find marginal cost by determining the extra expense of producing one additional product or unit of service. It’s important to properly calculate your marginal cost to estimate your profits after volume increases. When assessing the cost to make each product, it’s not as simple as buying more materials. Some questions to ask yourself are:

• How many more hours will it take to meet this new goal?
• Will I need to increase storage?
• Should I upgrade shipping methods and procedures to better suit the new quantity?
• Will I need to hire extra staff to help with production and sales?
• How will a more considerable profit margin affect my yearly taxes?
• Should I revisit my material supplier to see if I can get discounts for buying in bulk?
• If the extra product doesn’t sell, can I still make a profit if I have to discount them?

To find your marginal cost, add the additional costs that making more units will incur. It’s important to be thorough — account for every penny. Then, divide it by the number of units you will add.

X: Additional expenses

Y: How many units you’re adding

Z: Marginal cost

X/Y=Z

If the formula made your mind shut down (don’t worry, same), consider a simple business structure. For example, if you spent $20 to produce 20 units and it’s going to cost $10 for another 20 products, the marginal cost to add those 20 is $0.50 (or 10/20).

What Is Marginal Revenue?

Marginal revenue can help you determine the revenue you will receive per unit you add. Finding the marginal revenue is essential before making more products because it helps you:

• Figure out if you should raise or lower the price of your product
• How many units you should add
• Plan future steps

For instance, if adding 50 more products allows you to get a bulk deal from your material suppliers, you may be able to lower the price to sell more. But if you realize the additional units mean hiring extra staff, you may need to raise the price for everything to even out. That means they might not sell as quickly, and you’re stuck with a surplus you may need to discount later.

To determine marginal revenue, divide the difference in revenue by the number of products you add.

X: Revenue difference

Y: Additional units

Z: Marginal revenue

X/Y=Z

So, if you add 10 products and make $50 more in profits, you’re getting $5 more from the addition.

Market analysis is also an important part of determining marginal revenue — if you have a loyal customer base who buys a certain amount of product each month, are you sure you’ll be able to sell additional products for the same price? You may have to lower the cost to compete with other companies and get those extra sales.

How Does This information Help My Business?

Now that we know the difference, we can use the information to help determine if increasing your product numbers will net you more earnings. Ideally, the marginal cost and marginal revenue should be even — that way, you know you’re making the right amount of product. It’s always important to calculate the figures carefully and often to help you make informed decisions regarding the growth of your business.

Of course, there’s no way to determine the future. A big box corporation can move into your hometown and sell a similar product at a much cheaper rate (more on how to compete with this here). Or an influencer may use your product and cause sales to rocket. Inflation is also a factor. But determining these numbers can help you make an educated decision, which sets you up for success in the future.

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