Concept of Revenue

The concept of revenue forms an important tool for economic analysis. This is the lifeline for the producer of the firm in all market situations. Since revenue of a firm together with its costs determines profits, therefore the study of the concept of revenue is very important.

The revenue of firms is the receipt that it obtains from selling its products. Hence the curve depicting the amounts of revenue that it receives by selling the various quantities of a commodity is called revenue curve. Left witch has termed it as sales curve. Truly speaking, revenue here means sales revenue of the firm.

Similar to costs, revenue has also three main concepts:

Total Revenue (TR) Total Revenue refers to gross revenue, i.e. the total amount of money that the firm receives from the sale of its products.

Total Revenue can be estimated by multiplying the quantity sold by its selling price (or Average Revenue) or in other words, it is the sum total of marginal revenues. Thus,

TR = QXP (or AR)

Or        TR = ∑MR

Suppose, quantity sold (Q) = 25 units; Price = Rs. 10. Then, TR = 25×10 = Rs. 250.

Average Revenue (AR) Average Revenue is the total revenue (TR) divided by the quantity sold (Q) or it is the per unit revenue.

AR = QR/Q

Suppose,   TR = Rs. 250

Q = 25 units

Then,

AR = 250/25 = 10.

AR curve and Demand Curve are one and the same.

It should also be clear understood that average revenue (AR) and price for the product (P) have the same meaning received by the seller from the sale of the commodity. On the other, price means per unit payment made by the purchaser to purchase the commodity. Since seller receives what the purchaser pays, hence the per unit revenue and per unit price are one and the same thing. In fact what is average revenue from seller’s point of view, the same is the price from buyer’s point of view. Therefore AR and P are one and the same and that is why AR curve and Demand curve for firm’s product are also one and the same.

Marginal Revenue (MR) Marginal revenue is the changes in total revenue resulting from one unit increase in the sales. Marginal revenue can be estimated as the change in total revenue with the sale of n units of a product instead of n-1 units. Thus,

MR = TRn-1

Suppose,

Quantity sold (Units) Total Revenue Rs.
25 250
26 260

Then,

MR = 260 250 = Rs. 10.

Relationship between TR, MR and AR

The relationship between total revenue, average revenue and marginal revenue is explained with the help of following example and diagram:

 

Units of output TR (Rs.) MR (Rs.) AR (Rs.)
1 200 200 200
2 360 160 180
3 480 120 160
4 560 80 140
5 600 40 120
6 600 0 100
7 560 -40 80
8 480 -80 60

It is clear form the example and diagram that TR, MR and AR interrelated. AR and MR curves can also be derived from TR curve through geometrical method.

Relationship between TR and MR

  1. When marginal revenue is positive (i.e.,) greater than zero, total revenue rises. It is up to 5 units in our example.
  2. When marginal revenue becomes zero, total revenue is the maximum. It is evident from our example and diagram that at the 6th unit of the commodity MR is zero and TR is the maximum.
  3. When marginal revenue becomes negative, total revenue start to fall. This is the case from 7th unit onward in our example. The diagram also shows that when marginal revenue is negative, MR curve goes below the X-axis and TR curve also starts to decline.

Relationship between AR and MR

  1. When both AR and MR are falling, MR falls at a greater rate than the AR. In other words, if AR and MR are downward sloping curves, MR curve always remains below the AR curve.
  2. MR can be negative but AR is always positive (i.e. greater than zero). That is why AR curve always remain above the X-axis while MR curve can go below the X-axis.

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