How to Calculate Marginal Profit in Finance: Definition, Formula and Examples

Marginal Profit Definition

Marginal profit is the additional profit a company earns by selling one more unit of a product or service.

It is calculated as the difference between marginal revenue and marginal costs.

 

Calculating marginal profit helps businesses understand how changes in sales volume and production costs impact profitability.

 

For example, imagine a bakery that decides to produce an additional batch of cupcakes.

 

The marginal profit for this batch would depend on the additional revenue generated from selling the cupcakes versus the additional costs incurred, such as ingredients, labour, and energy.

 

If the bakery calculates that the revenue from selling the extra cupcakes exceeds the additional costs, the marginal profit is positive, indicating that producing the extra batch is financially beneficial.

 

This can help the bakery make strategic decisions about pricing and production to maximise overall profitability.

How to Calculate Marginal Profit

Marginal Profit Formula

Calculating marginal profit uses the formula:

Marginal Profit = Marginal Revenue − Marginal Cost

Where:

 

  • Marginal Revenue = This is the additional revenue generated from selling one more unit of a product or service.

 

  • Marginal Cost = This is the additional cost incurred when producing one more unit of a product or service.

 

  • Marginal Profit = This is the additional profit gained from selling one more unit of a product or service.

Calculating Marginal Profit Step-by-Step

Let’s walk through how to calculate marginal profit step-by-step:

Step 1: Calculate Marginal Revenue

Marginal revenue is the additional revenue a company earns by selling one more unit of a product or service.

 

Marginal Revenue = Change in Total Revenue / Change in Quantity

Step 2: Calculate Marginal Cost

Marginal cost is the additional cost a company incurs to produce one more unit of a product or service.

 

Marginal Cost = Change in Total Cost / Change in Quantity

Step 3: Calculate Marginal Profit

Using the marginal profit formula:

 

Marginal Profit = Marginal Revenue − Marginal Cost

Example Marginal Profit Calculation

Let’s now walk through a full working example of how to calculate marginal profit.

 

Imagine a company that sells widgets and has the following data:

Production Level (Widgets)

Total Revenue

Total Cost

100

£2,000

£1,500

101

£2,010

£1,505

The selling price per widget is determined by market demand, so increasing production requires lowering the price.

 

We will calculate the marginal profit for producing and selling the 101st widget.

Step 1: Calculate Marginal Revenue

To calculate marginal revenue, we need to know the change in total revenue and the change in quantity:

 

Total revenue increases from £2,000 to £2,010, so £2,010 – £2,000 = £10

 

Production quantity increases from 100 to 101, so 101 – 100 = 1

 

Now we can calculate marginal revenue:

 

Marginal Revenue = Change in Total Revenue / Change in Quantity

Marginal Revenue = £10 / 1 = £10

 

Therefore, Marginal Revenue = £10

Step 2: Calculate Marginal Cost

To calculate marginal cost, we need to know the change in total revenue and the change in quantity:

 

Total cost increases from £1,500 to £1,505, so £1,505 – £1,500 = £5

 

Production quantity increases from 100 to 101, so 101 – 100 = 1

 

Now we can calculate marginal cost:

 

Marginal Cost = Change in Total Cost / Change in Quantity

Marginal Cost = £5 / 1 = £5

 

Therefore, Marginal Cost = £10

Step 3: Calculate Marginal Profit

Now we can plug the marginal revenue and marginal cost numbers into the formula for marginal profit:

 

Marginal Profit = Marginal Revenue − Marginal Cost

Marginal Profit = £10 − £5 = £5

 

Therefore, producing and selling the 101st widget generates an additional profit of £5 for the company.

When Does Marginal Profit Become Negative?

In the same way that a company can have a negative profit (ie a loss), marginal profit can also become negative.

 

This happens when the additional cost of producing or selling one more unit exceeds the additional revenue generated.

 

Typically, marginal profit turns negative when a business exceeds its optimal level of output, leading to lost economies of scale and increased inefficiencies.

 

Other contributing factors may include rising production costs, declining demand or lowering prices to attract more customers.