Download Calculating the Revenue of a Firm

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
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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.
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