Back

Revenue

Revenue is the total income a business generates from selling its goods or services over a specific time period. It serves as a crucial indicator of a company’s financial health and success. There are three key types of revenue to understand:

  1. Total Revenue (TR):
    This represents the total income earned from selling a specific quantity of goods or services. It is calculated by multiplying the price of the product by the quantity sold.
  • Formula: TR = Price × Quantity Sold.

2. Average Revenue (AR)

  • Average revenue refers to the revenue earned per unit of output sold. It is calculated by dividing the total revenue by the quantity of goods sold.
  • Formula: AR = TR ÷ Quantity Sold.
  • In perfectly competitive markets, the average revenue is equal to the price of the product, as each unit is sold at the same price.

3. Marginal Revenue (MR): 

  • Marginal revenue is the additional revenue a business earns by selling one extra unit of its product. It is calculated as the change in total revenue divided by the change in quantity sold.
  • Formula: MR = Change in TR ÷ Change in Quantity.
Reference Link for the above content:

Relationship Between TR, AR, and MR

  • When AR is constant (perfect competition), MR = AR = Price, and TR increases at a constant rate.
  • Under imperfect competition, AR falls with every additional unit sold due to the downward-sloping demand curve, and:
    • MR < AR
    • MR falls faster than AR

TR=AR×Q

A graphical view helps:

  • TR rises initially, reaches a maximum, then declines.
  • MR is the slope of the TR curve; it cuts the horizontal axis when TR is at its peak.
  • AR curve lies above the MR curve under monopoly or monopolistic competition.

Concepts of Increasing, Constant, and Decreasing MR

  • Increasing MR:
     Rare in real-world scenarios. It occurs when each additional unit sold brings in more revenue than the previous one—only possible if prices rise with quantity sold, which contradicts normal demand behavior.
  • Constant MR:
     Seen under perfect competition, where the price remains constant regardless of output level. Here:
    • MR = AR = Price
    • TR increases linearly with output.
  • Decreasing MR:
     Typical under monopoly or monopolistic competition where:
    • To sell more, the firm must reduce the price.
    • MR declines faster than AR.
    • Eventually, MR can become zero or even negative (TR starts falling).

Relationship Between AR, MR, and Price Elasticity of Demand

Understanding how marginal revenue relates to average revenue and price elasticity of demand is crucial in microeconomic theory, especially in determining a firm’s pricing and output decisions under imperfect competition.

Mathematical Relationship Between AR, MR, and e:

A firm’s MR can be derived from AR and e using the formula:

Interpretation of the Formula:

Let’s break this down:

1.When demand is elastic (e > 1):

  • MR is positive
  • TR increases with additional output
  • Firm is in the revenue-increasing zone

2. When demand is unit  lastic (e = 1):

  • MR is zero
  • TR is maximum
  • Firm is at the peak of the TR curve

3. When demand is inelastic (e < 1):

  • MR is negative
  • TR decreases with additional output
  • Firm should reduce output to increase TR

Economic Significance:

  • This relationship helps firms decide:
    • Whether to expand or reduce output
    • At what point total revenue is maximized
    • Whether price cuts will increase or decrease revenue

Firms will usually avoid operating where MR < 0 or e < 1, as producing more leads to a fall in total revenue.

Need Help?
error: Content is protected !!