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Calculating the Revenue of a Firm Revenue is the income generated from the sale of goods and services in a market Average Revenue (AR) = Price per unit = total revenue / output (the AR curve is the same as the demand curve) Marginal Revenue (MR) = the change in revenue from selling one extra unit of output Total Revenue (TR) = Price per unit x quantity The table below shows the demand for a product where there is a downward sloping demand curve. Price per unit (average revenue) Quantity Demanded (Qd) Total Revenue (TR) (PxQ) Marginal Revenue (MR) £s units £s £s 340 460 156400 310 580 179800 195 280 700 196000 135 250 820 205000 75 220 940 206800 15 190 1060 201400 -45 Average and Marginal Revenue In the table above, as price per unit falls, demand expands and total revenue rises although because average revenue falls as more units are sold, this causes marginal revenue to decline Eventually marginal revenue becomes negative, a further fall in price (e.g. from £220 to £190) causes total revenue to fall. The Relationship between Elasticity of Demand and Total Revenue When a firm faces a perfectly elastic demand curve, then average revenue = marginal revenue – each unit sold add the same amount to total revenue However, most businesses face a downward sloping demand curve! And because the price per unit must be cut to sell extra units, therefore MR lies below AR. MR curve will fall at twice the rate of the AR curve. You don’t have to prove this for exams – the marginal revenue curve has twice the slope of the AR curve! Maximum Revenue Maximum total revenue occurs where marginal revenue is zero: no more revenue can be achieved from producing an extra unit of output This point is directly underneath the mid-point of a linear demand curve When marginal revenue is zero, the price elasticity of demand = 1 When marginal revenue is zero, if prices were cut total revenue would fall, and if prices were raised total revenue would fall Total revenue when demand has low price elasticity If price elasticity of demand < 1 (i.e. demand is inelastic), if prices are cut then demand rises by a smaller proportion. Cutting price when demand is relatively inelastic means total revenue falls, or MR<0 © Tutor2u Limited 2014 www.tutor2u.net Total revenue is maximized when MR = 0 Revenue Total Revenue (TR) Ped >1 for a price fall along this length of AR Price elasticity of demand = 1 at this output Average Revenue (Demand) AR Marginal Revenue (MR) Output (Q) Total revenue is shown by the area underneath the firm’s demand curve (average revenue curve). Costs Total revenue at price P1 where marginal revenue is zero P2 A rise in price to P2 causes a reduction in total revenue P1 Average revenue AR Total revenue at price P2 Q2 Q1 Marginal revenue MR Output (Q) A shift in the average revenue curve (AR) will also bring about a shift in the marginal revenue curve (MR) Seasonal revenues: Many businesses experience seasonal fluctuations in revenues because the strength of demand ebbs and flow at different times of the year. Good examples of seasonal shifts in demand and revenues include beer producers, chocolate and card retailers, tourist attractions, online dating sites, jewellers and perfumery businesses. © Tutor2u Limited 2014 www.tutor2u.net