Marginal Profit

Marginal Profit

Marginal profit is the change in profit from producing and selling one additional unit of a good or service. It equals the extra revenue earned from that unit (marginal revenue) minus the extra cost of producing it (marginal cost).

Key formula:
* Marginal profit = Marginal revenue (MR) − Marginal cost (MC)

Why it matters

Marginal profit helps managers decide whether to increase, maintain, or reduce production. A firm maximizes total profit by producing up to the point where MR = MC, at which marginal profit is zero. If marginal profit is positive, producing another unit increases total profit; if negative, producing another unit reduces total profit.

In perfectly competitive markets, competition drives price toward marginal cost, so firms often face zero marginal profit at the profit-maximizing output.

Understanding scale effects

• Economies of scale: As production increases, marginal cost may fall, raising marginal profit.
• Diseconomies of scale: Beyond a certain point, marginal cost rises and marginal profit declines, potentially becoming negative.
• Firms typically expand output until MR = MC. If marginal profit turns negative and is expected to remain negative, management may cut production or stop operations.

What to include (and exclude) in marginal profit calculations

Include costs that change with one more unit:
* Direct labor for the extra unit
* Variable materials and supplies
* Additional energy or processing costs
* Incremental taxes or interest tied to extra production

Exclude fixed or sunk costs that do not change with the next unit:
* Capital expenditures already spent (plant, machinery)
* Allocated overhead that won’t change in the short run

Avoid the sunk cost fallacy—past unrecoverable expenses should not affect marginal decisions.

Practical considerations and limitations

• Marginal profit looks only at the next unit, not overall profitability.
• Managers often estimate marginal costs and revenues rather than observe them in real time, so decisions involve forecasting and judgment.
• Many firms operate below maximum capacity to allow flexibility for demand spikes.
• Market frictions, regulation, and imperfect information mean MR = MC is an idealized rule rather than an exact real-world outcome.

Quick examples

• If MR = $50 and MC = $40, marginal profit = $10 → produce the extra unit.
• If MR = $50 and MC = $55, marginal profit = −$5 → avoid producing the extra unit.

When to shut down

If marginal profit is negative across all feasible output levels (i.e., every additional unit reduces loss), the firm should consider halting production until conditions improve.