Introduction
A company's revenue is what it earns from selling commodities, and services to consumers, which are its normal business pursuits. It is also called turnover or sales. Royalties, fees, or interests may also be a source of revenue.
By setting a cost price less than or equivalent to the market cost price, an enterprise believes it can sell as many quantities of its product as it needs. The rationale for lowering the cost price of a product is lost in such a scenario. As a result, the enterprise should set a cost price that matches the market price of the commodity to the greatest extent possible.
The Types of Revenues
Total revenue: The total revenue is the total amount a vendor can collect from the sale of commodities or services to the customer. The price of the commodities can be expressed as P × Q, which means the cost price of the commodities multiplied by the amount sold. Therefore, total revenue (TR) is defined as the market cost price of the commodity (p) multiplied by the enterprise's output (q).
Thus,
TR = p × q
Where
TR-Total Revenue,
P-Price,
Q-Quantity.
Average revenue: The average revenue represents the revenue initiated per unit of output sold. The average revenue contributes greatly to the profit of any enterprise. In calculating profit per unit, the average (total) cost is subtracted from the average revenue. It is usually more profitable for an enterprise to manufacture the greatest amount of output.
AR = TR/q = p × q/q = p
Where
AR-Average Revenue,
TR-Total Revenue,
P-Price
Q-Quantity.
Marginal revenue: It is defined as the revenue earned from the sale of a new product or unit. In other words, it is the revenue that a company generates when it sells an extra unit. Management uses it to analyze customer demands, plan the production schedules, and set the prices of products.
In accordance with the law of diminishing returns, the margin of revenue remains constant to a certain output level, and slows down as output increases.
MR = Change in total revenue/Change in quantity
Where
MR-Marginal Revenue,
TR-Total Revenue,
Q-Quantity.
FAQs on Revenue Concepts: Total, Average, and Marginal
1. What are Total Revenue (TR), Average Revenue (AR), and Marginal Revenue (MR) in economics?
These are three fundamental concepts used to analyse a firm's income from sales.
- Total Revenue (TR) is the total amount of money a firm receives from selling a given quantity of its product. It is calculated as Price (P) multiplied by Quantity sold (Q), so TR = P × Q.
- Average Revenue (AR) is the revenue earned per unit of output sold. It is calculated by dividing the Total Revenue by the quantity sold (AR = TR / Q). Importantly, Average Revenue is always equal to the price of the product (P).
- Marginal Revenue (MR) is the additional revenue generated from selling one more unit of a product. It is the change in Total Revenue when one more unit is sold (MR = ΔTR / ΔQ).
2. How can you calculate TR, AR, and MR with an example?
To calculate these values, you need data on price and quantity. For example, if a firm sells its product at different prices:
- If 1 unit is sold at ₹10, TR is 1 × ₹10 = ₹10. AR is ₹10/1 = ₹10. MR for the first unit is ₹10.
- If 2 units are sold by lowering the price to ₹9, TR is 2 × ₹9 = ₹18. AR is ₹18/2 = ₹9. MR for the second unit is (₹18 - ₹10) / (2-1) = ₹8.
- If 3 units are sold by lowering the price to ₹8, TR is 3 × ₹8 = ₹24. AR is ₹24/3 = ₹8. MR for the third unit is (₹24 - ₹18) / (3-2) = ₹6.
3. What is the relationship between Total Revenue (TR) and Marginal Revenue (MR)?
The relationship between Total Revenue and Marginal Revenue is direct and crucial for understanding a firm's output decisions.
- When MR is positive and falling, TR increases but at a diminishing rate. Each additional unit sold still adds to the total revenue.
- When MR is zero, TR reaches its maximum point. Selling one more unit at this stage will not add anything to the total revenue.
- When MR becomes negative, TR starts to decline. This means that selling an additional unit actually reduces the firm's total revenue because the price cut needed to sell it outweighs the income from that unit.
4. Why are the Average Revenue (AR) and Marginal Revenue (MR) curves different in imperfect competition but the same in perfect competition?
The behaviour of AR and MR curves depends on the market structure:
- In perfect competition, a firm is a price-taker and can sell any quantity at the constant market price. Since the price per unit (AR) is fixed, the additional revenue from selling one more unit (MR) is also the same as the price. Therefore, the AR and MR curves are the same, represented by a horizontal line parallel to the x-axis.
- In imperfect competition (like monopoly or monopolistic competition), a firm must lower its price to sell more units. This lower price applies to all units sold, not just the extra one. As a result, the MR is always less than the AR (Price). Both curves slope downwards, but the MR curve lies below the AR curve.
5. What is the key difference between Average Revenue and Marginal Revenue?
The key difference lies in what they measure. Average Revenue (AR) measures the revenue per unit across all units sold (AR = Total Revenue / Quantity). It is essentially the price of the product. In contrast, Marginal Revenue (MR) measures the change in total revenue resulting from the sale of just one additional unit. While AR gives an average perspective, MR provides an incremental perspective, which is vital for making production decisions.
6. Why is understanding Marginal Revenue so important for a firm?
Understanding Marginal Revenue is critical for a firm's goal of profit maximisation. A rational firm will continue to produce additional units as long as the Marginal Revenue (MR) from a unit is greater than or equal to its Marginal Cost (MC). The profit-maximising level of output is achieved at the point where MR = MC. If a firm produces beyond this point (where MR < MC), it will lose money on each additional unit, reducing its overall profit.
7. What does it signify when a firm’s Marginal Revenue (MR) becomes zero or negative?
The value of Marginal Revenue provides a strong signal to the firm:
- When MR is zero, it indicates that the firm has reached its maximum possible Total Revenue. Selling one more unit will not increase TR any further. This is the peak of the TR curve.
- When MR is negative, it signifies that to sell an additional unit, the firm had to lower its price so much that its Total Revenue actually decreased. A firm seeking to maximise profit or revenue would never choose to produce at a level where its MR is negative.
