What is the difference between marginal cost and marginal revenue?

Whether you run a bustling restaurant, a busy retail shop, or a growing e-commerce store, every decision you make has a financial consequence. Should you produce one more unit? Hire another member of staff? Stock a new product line? Fortunately, two fundamental economic concepts can help answer these questions: marginal cost and marginal revenue.

These two figures are the heartbeat of profitable business decision-making. Get the balance right: you maximize profit. Ignore them, and you could end up producing too much, charging too little and watching your margins go poof! 

Let's break down what each term means, how they differ, and why they matter to your business, so you can start making smart choices from here on out. 

What is marginal cost?

Marginal cost is the cost of producing one additional unit of a product or service. This could mean opening for an extra hour, baking an extra batch of almond croissants or taking on one more table during a busy service.

To understand marginal cost properly, you need to know what it leaves out. Fixed overheads such as rent, insurance, and salaried staff aren't included because those costs exist regardless of how much you produce. Marginal cost focuses exclusively on variable expenses that change with the amount you produce, including raw materials, packaging, hourly wages, utilities, and so on. 

The marginal cost formula

So, how exactly do you figure out marginal cost? Well, lucky for you, there’s a simple, bulletproof formula that produces the magic number.

Marginal cost = change in total cost ÷ change in quantity

Imagine you run a bakery. You currently bake 100 loaves a day, and your total variable costs are £300. If you bake 110 loaves instead, and your total variable costs rise to £330, your marginal cost is:

£330 − £300 = £30 increase in cost

£30 ÷ 10 extra loaves = £3 per loaf

According to this formula, each additional loaf will cost you £3 to produce. Now that you have this information, you can better gauge if baking extra loaves is worth your time. 

Why does marginal cost change?

Here’s the thing about marginal costs: they rarely stay flat. At first, producing more units often becomes cheaper per unit, a phenomenon known as economies of scale. When you buy ingredients in bulk, your staff becomes more efficient, and your processes improve.

But if you push production too far, the marginal cost starts to rise instead. Here’s why: equipment wears out faster, staff work overtime, and you run out of storage space (for example). This is known as diminishing returns, and it's one of the most important things to watch for in any growing business. 

This doesn’t mean you shouldn’t be ambitious when it comes to expanding your business, but you should be aware that growth and profitability aren't always the same thing. The crucial thing is to ensure you have a plan that goes beyond just selling more. 

What is marginal revenue?

Marginal revenue is the additional income earned from selling one more unit of a product or service.

In a simple, perfectly competitive market, marginal revenue equals the price of the product, and every additional sale brings in the same amount. In the real world, however, things are a little more nuanced. Depending on demand, competition, and your pricing strategy, the revenue you earn from each additional sale can vary. While confusing, this can make a big difference!

The marginal revenue formula

Marginal revenue = change in total revenue ÷ change in quantity

Your bakery sells 100 loaves at £5 each, bringing in £500. You decide to bake and sell 10 more loaves. but to shift them all, you drop the price slightly to £4.90. Your new total revenue is £539.

£539 − £500 = £39 increase in revenue
£39 ÷ 10 extra loaves = £3.90 per loaf

So each additional loaf earns you £3.90 in marginal revenue.

Why does marginal revenue decline?

As you sell more, you typically need to lower your prices to attract additional customers. This means each new sale adds a little less to your total income than the last one. This declining marginal revenue is a normal feature of most real-world markets, and understanding it helps you avoid the trap of chasing volume at the expense of profit.

Marginal cost vs marginal revenue 

The sweet spot: where marginal cost meets marginal revenue

This is where it all clicks into place. Profit is maximized at the exact point where what it costs to produce one more unit equals what you earn from selling it: MC = MR. This is a foundational principle of economics, and it's surprisingly practical. Here are a few pointers:

• If marginal revenue > marginal cost, producing more adds to your profit. You should increase output.

• If marginal cost > marginal revenue, producing more is costing you more than you're earning. You should reduce output.

• If marginal cost = marginal revenue, you've hit the sweet spot: producing any more or less would reduce your overall profit.

Now, let's head back to the bakery and apply what we've just learnt. Your marginal cost is £3 per extra loaf, and your marginal revenue is £3.90 per extra loaf. Since MR > MC, it makes sense to bake those additional loaves. But if costs rose to £4.20 per loaf while revenue stayed at £3.90, you'd be losing money on every extra unit. Using these concepts, it’s clear you must pull back.

Why this matters for your business

Here’s the good news: you don't need to be a fancy economist to apply these concepts. In fact, you might already be thinking about marginal cost and marginal revenue intuitively, just without using these exact terms.

Here's how this plays out in real business situations: 

Pricing decisions

Before running a discount promotion, ask yourself: Will the extra sales volume generate enough marginal revenue to outweigh the lower price per unit? If your margin is already thin, a 20% discount might bring in more customers but actually leave you worse off.

Staffing

Hiring an extra member of staff is a marginal cost. The question is whether that person will generate enough extra revenue to justify the wage. If a new till operator helps you serve 30 more customers per shift, each spending an average of £15, the marginal revenue picture becomes much clearer.

Inventory and stock levels

Should you order an extra pallet of your best-selling product? Calculate what that stock will cost you (marginal cost) and compare it to what you expect to sell it for (marginal revenue). Factor in storage costs, potential spoilage, and demand forecasts.

Expanding your menu or product range

Every new product line carries its own marginal costs: ingredients, training, preparation time, and storage. Before you add something new, you’ll need to assess whether the expected sales revenue will cover those costs and contribute to profit.

If you'd like to dig deeper into profit margins and what good looks like for your industry, give our guide on retail profit margins a read. 

How point of sale data helps you track marginal figures

To make good decisions around marginal cost and marginal revenue, accurate, real-time data is crucial. This is where a modern EPOS system comes in. 

With the right point of sale technology, you can:

• Track sales by product line to see which items generate the most revenue per unit

• Monitor stock and ingredient usage to calculate your true variable costs

• Identify peak trading periods to understand where additional production has the most impact

• Analyse margin by product so you're never guessing which items are pulling their weight

• Spot diminishing returns early before overproduction starts eating into profit

When your sales data, inventory, and financials are all connected in one system, Epos Now makes calculating marginal revenue and keeping an eye on marginal costs far less daunting and far more doable. 

Common mistakes to avoid

1. Confusing marginal cost with average cost: Your average cost per unit might look healthy, but if your marginal cost is rising fast, you could be heading for trouble without realizing it. Top tip: always look at both.

2. Ignoring marginal revenue when discounting: Discounting feels like a smart way to attract more customers, but if your selling price drops below what it costs to produce each unit, you're in trouble. 

3. Assuming marginal cost stays constant: Many business owners assume that producing more always costs the same per unit. In reality, costs often rise as you start doing more, a factor that’s important not to overlook. 

4. Focusing only on total revenue and total cost: It's easy to focus on your total revenue and total cost, but those numbers only tell you how you've done, not what you should do next. Marginal figures are important because they give you an informed insight into what your next move should be.

Final thoughts

Marginal cost and marginal revenue are two sides of the same coin. At the end of the day, they tell you whether the next unit you produce or sell will make you richer or poorer.

Understanding this relationship is the difference between growing smartly and growing recklessly, and it’s valuable for businesses of all shapes and sizes. The good news is, you don't need complex spreadsheets or an economics degree. Instead, all you need is good data, a clear view of your costs, and the discipline to ask one simple question before every major decision: Will the next unit make more than it costs?

If the answer is yes, go for it. If it isn't, hold back, reassess, and take time to strategize. By understanding these two concepts, it really can be that simple.

Looking for a smarter way to track your sales, costs, and margins in real time? Epos Now's cloud-based EPOS systems give you the data you need to make decisions like this every day, with ease.