Revenue
The different kinds of revenue and their curves
Definition of Revenue: 'Revenue is the money made by firms from selling their goods and services'.
You need to be concerned with 3 types of revenue: Total, Average and Marginal
Total Revenue = Price x Quantity: It is the total amount of revenue the firms makes from selling all of its products
Average Revenue = Price: It is exactly the same thing as the price per unit
Marginal Revenue = The addition to total revenue when the firm sells one more unit.
Some diagrams:
[I'm going to make this as simple as I possibly can without going into the nitty gritty stuff which you don't actually need!]
Diagram 1: Average Revenue - Price Makers
The curve above is the average revenue curve. Out of all the revenue curves it is probably the one you will be using in most applications. The average revenue curve is also known as the demand curve, which you must have learned in the first year of economics. At any given point, you can work out the total revenue the firm makes. Take for example, point A. At point A, price = £10 and quantity = 150 units. Total revenue is therefore £1500 (£10 x 150 units), which is all the money the firm receives.
Diagram 2: Introduction of Marginal Revenue - Price Makers
The above diagram now includes the marginal revenue curve. The marginal revenue curve shows us how much extra revenue the firm makes when they sell one more unit of output. Think - if the firm wants to increase their output from 100 units to 101 units, then they must decrease the price of all their goods. If price was initially £8, then total revenue before would be £800. To increase sales to 101 units, the firm must decrease price, let's say to £7.95. What is the total revenue now? £7.95 x 101 units = £802.95. So what is the marginal revenue? MR = £+2.95. This is the extra revenue they have made.
At the point MR = 0, we have reached the point where additional units of output will lose the firm revenue. This is therefore the point where the firm maximises its revenue.
Diagram 3: Total Revenue - Price Makers
The diagram above shows the total revenue curve. It is probably the least important diagram of the three diagrams on this page. You will not use it so much in your exam, but it is still good to know.
The firm's total revenue increases as output increases. But increases in output will not mean the firm make more revenue forever. At point A, we have reached the revenue maximum. Beyond this, the firm will start to take in less money. It's also worth pointing out that at point A, we are also at the same point A in diagram 2, where MR = 0.
The above diagrams are all for the price maker. Are the revenue diagrams different for price taking firms, like in a competitive market?
Yes, they are very different. You have to remember these differences.
Diagram 4: Average and Marginal Revenue - Price Takers
The above diagram shows the AR and MR curves for the price taking firm. As you can see, in this diagram, AR and MR are exactly the same. Why? Because the firm is a price taker, which means their demand curve is perfectly elastic. There is only one price in the market, the market price - and the firm must sell at that price only. So therefore, any extra units sold are at the one price that the market provides.
Diagram 5: Total Revenue Curve - Price Takers
The above diagram shows the total revenue curve for the price taking firm. In this example, the total revenue curve is a straight line. This is completely different to diagram 3. In diagram 3, the total revenue curve was a curved line. But this was for a price making firm, not a price taking firm.
The price taking firm only has one price, the market price. This means that when they sell an extra nit of output, their revenue increases by the market price. For example, if the market price is £5 and you sell 50 units, you make £250. If you sell 51 units, the price is still the same (£5) and you make £255, so an extra £5. Because the total revenue is going up in £5 increments it makes a pefectly straight line.
What have we learned:
The definition of revenue
The 3 kinds of revenue
3 revenue diagrams for price makers
2 revenue diagrams for price takers
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