Marginal revenue is the extra income from selling one more unit. If a company sells 100 widgets and the 101st brings in $10, marginal revenue is $10. In perfect competition, marginal revenue equals price. In most real markets, it is lower because sellers must cut prices to sell more.

The relationship between marginal revenue and marginal cost determines profit. A firm maximizes profit where the two are equal. Below that point, selling more adds to profit. Above it, selling more reduces profit. This rule applies to lemonade stands and airlines alike.

Airlines illustrate the logic well. A seat sold at the last minute for $150 may have a marginal cost of $20. Marginal revenue far exceeds marginal cost, so the airline sells. But if it discounts too many seats, it cannibalizes full-fare sales. The math gets complicated fast.

Key points

• Change in total revenue divided by change in quantity
• Equals price in perfect competition
• Falls as quantity rises in imperfect competition
• Equals marginal cost at profit maximum
• Drives pricing strategy