Revenue Curve

REVENUE CURVE

By: Pawandeep Kaur Maninder Singh

What is revenue? By selling a commodity whatever money a firm receives is called revenue. In words of Dooley, “The revenue of a firm is its sales receipts or money receipts from the sale of a product.” It is also called sale proceeds.

Revenue and profit are different concepts The following equation shows the difference: Profit = Revenue – Cost or Revenue = Cost + Profit

Variants of revenue 1) Total revenue (TR) 2) Marginal revenue (MR) 3) Average revenue (AR)

Total revenue (TR) The revenue that a firm gets by selling a given output is total revenue. For example, If 100 ice creams slabs are sold at the rate of Rs 50 per slab, TR of the firm will be: Output * Price = Total revenue 100 * Rs 50 = Rs 5000 Total revenue is total money receipts of a producer corresponding to a given level of output. Or, TR = AR * Q

(Here, TR = Total revenue AR = Revenue per unit of output Q = Total output )

Marginal revenue (MR) Marginal revenue is the total revenue which results from the sale of one more (or one less) unit of commodity. In order to calculate the MR: MR = (Change in total revenue) / (change in quantity sold) = ( ᅀ TR) / ( ᅀ Q) or, MR = TRn – TRn-1 and, ∑MR = TR Marginal revenue is the change in total revenue on account of the sale of one more (or one less) unit of output.

Average revenue Average revenue refers to revenue per unit of output sold. AR = TR / Q Average revenue is the per unit revenue received from the sale of a commodity. It is the same as price of the commodity. AR = TR/Q = (P*Q) / Q = P

What happens if AR is constant? AR is constant (means price is constant), then MR is also constant. Constant MR implies constant addition to TR when an additional unit of output is sold. This implies that TR will increase at a constant rate. Output Q (units) 1

AR = P (Rs)

TR = AR * Q

10

10

MR = TRn – TRn-1 10 – 0 = 10

2

10

20

20 – 10 = 10

3

10

30

30 – 20 = 10

REVENUE (Rs)

TR

AR = MR

REVENUE (Rs)

OUTPUT (units)

OUTPUT (Units)

What happens if AR is not constant? Q

AR = P

TR = AR * Q

MR = TRn – TRn-1

1

10

10

10

2

9.5

19

9

3

9

27

8

In this case, as AR is declining by Re 0.5, MR is declining by Re 1. This proves that under monopoly and monopolistic competition MR declines faster than AR. So AR > MR. And TR increases at diminishing rate.

Can MR be zero or negative? Q (units)

AR = P (Rs) 100

TR = AR * Q (Rs) 100

MR = TRn – TRn-1 (Rs) 100

1 2

75

150

50

3

50

150

0

4

30

120

-30

Yes, but only when price is declining as under monopoly or monopolistic competition. TR stops increasing when MR = 0 so that TR is maximum when MR = 0 and starts declining when MR is negative.

AVERAGE / MARGINAL REVENUE (Rs)

TOTAL REVENUE (Rs)

TR is max

TR

OUTPUT (Units)

OUTPUT (units)

MR(-ve) AR

Revenue curve in different markets Broadly, markets are of three types: 1) Perfectly competitive market 2) Monopoly market 3) Monopolistic competitive market

Perfectly competitive market

REVENUE (Rs)

A firm is a price taker. It can sell any number of units of output at the prevailing price. If a firm tries to sell at a price higher than market price, it will lose all its customers. Constant price means constant AR, hence constant MR and TR increasing at constant rate. AR and MR curves are perfectly elastic under AR = MR perfect competition.

OUTPUT (Units)

Monopoly market The AR and MR curves under monopoly slope downwards from left to right. It means that if a monopolist desires to sell more, he has to reduce price of the product. A monopolist by definition is a price maker. Being a single seller of the product in the market, he can fix whatever price he wishes to. But, he can sell more only if he lowers the price of the product. Thus, there is negative relationship between price of the product and demand for the product in a monopoly market. Accordingly AR curve slopes downwards means there is inverse relationship between AR (price) and output.

Revenue curve under monopoly AR = P 10 9 8

REVENUE (Rs)

Q 1 2 3

TR = AR * Q 10 18 24

AR MR OUTPUT (Units)

MR = TRn – TRn-1 10 8 6

Monopolistic competitive market Revenue curves under monopolistic competition are similar to monopoly. The difference is that under monopolistic competition AR and MR are more elastic. It means that in response to a change in price, the change in demand will be relatively more as compared to monopoly market. It is because monopolistic competitive market goods have close substitutes. On the other hand monopoly market goods do not have close substitutes.

REVENUE (Rs)

Revenue curve under monopolistic competitive market

MR

AR

OUTPUT (Units)

REVENUE (Rs)

Comparative look

Perfect competition

Monopolistic competition Monopoly

OUTPUT (Units)

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