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Marginal revenue is defined as the increase in the revenue earned by a business when one extra unit is sold. Marginal revenue can be obtained by calculating the increase in total revenue divided by the increase in the total number of units sold.
Marginal revenue is not constant for any business. It is a function of the demand for the product and varies with the number of competitors, the type of product, the choice of the customers and the alternatives available.
To maximize profits any business should only increase production till the marginal revenue is equal to the marginal cost; marginal cost is the extra amount to be spent in creating one more unit of the product being sold.
As an example, take the case of a firm manufacturing high-end premium jewelery. As the number of pieces sold increases, customers would be less willing to pay very large amounts for the jewelery. There may even come a time where the firm is not able to get back an amount equal to the cost of the product as consumers are satisfied and do not want any more of it. In this type of a case it is essential for the firm to stop production once marginal revenue equals marginal costs. Else its operations become loss making.
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