7.19 - Revenue
The meaning of revenue and its types
Revenue refers to the money a firm earns from selling its goods or services, often called sales. It is typically measured over a specific period, such as a month or a year.
Total revenue
Total revenue (TR) is the overall income from sales, calculated by multiplying the price per unit by the quantity sold.
Where:
- TR = Total revenue (£)
- P = Price per unit (£)
- Q = Quantity sold (units)
Average revenue
Average revenue (AR) shows the revenue earned per unit sold.
Where:
- AR = Average revenue (£ per unit)
- TR = Total revenue (£)
- Q = Quantity sold (units)
Marginal revenue
Marginal revenue (MR) represents the extra revenue gained from selling one additional unit of output.
Where:
- MR = Marginal revenue (£ per unit)
- ΔTR = Change in total revenue (£)
- ΔQ = Change in quantity sold (units)
The type of market a firm operates in influences how these revenue measures behave.
Revenue in competitive markets for price takers
In a perfectly competitive market, firms lack control over the price of their products and must accept the market-determined price. These firms are known as price takers.
Characteristics of revenue for price takers:
- The firm's demand curve is horizontal, meaning its revenue depends solely on the quantity sold.
- While the individual firm's demand is horizontal, the overall market demand curve slopes downwards.
Revenue in non-competitive markets for price makers
In markets that are not perfectly competitive, such as monopolies or oligopolies, firms have some influence over price. These firms are known as price makers.
Characteristics of revenue for price makers:
- The firm's demand curve slopes downwards, so to sell more output, the firm must lower its price.
- Reducing output allows the firm to raise its price.
- Changes in output directly affect both price and revenue.
- The firm's demand curve is the same as its average revenue curve.
- Marginal revenue is always less than average revenue, because selling an extra unit requires lowering the price.
The relationship between revenue and price elasticity of demand
Price elasticity of demand (PED) determines how changes in quantity sold affect total revenue, with different effects in elastic, unitary, and inelastic regions of the demand curve.
How PED influences revenue changes:
- Elastic PED (PED > 1) - A price decrease leads to a proportionally larger increase in quantity demanded, raising total revenue. Conversely, a price increase reduces total revenue.
- Unitary PED (PED = 1) - Changes in price cause proportional changes in quantity demanded, leaving total revenue unchanged.
- Inelastic PED (PED < 1) - A price decrease results in a proportionally smaller increase in quantity demanded, reducing total revenue. A price increase boosts total revenue.