3.3.1 Revenue (Edexcel)

This Edexcel study note looks at revenue.

a) Formulas for Revenue Concepts:

Total Revenue (TR): Total Revenue is the total amount of money a firm earns from selling a certain quantity of goods or services at a given price. It is calculated by multiplying the quantity sold (Q) by the price per unit (P).

TR = P * Q

Average Revenue (AR): Average Revenue, also known as the price per unit, is the revenue generated by each individual unit sold. It is calculated by dividing the total revenue (TR) by the quantity sold (Q).

AR = TR / Q

Marginal Revenue (MR): Marginal Revenue is the additional revenue generated by selling one more unit of a product. It is calculated by finding the change in total revenue when one more unit is sold.

MR = ΔTR / ΔQ

Where ΔTR is the change in total revenue and ΔQ is the change in quantity sold.

b) Price Elasticity of Demand (PED) and Its Relationship to Revenue Concepts:

Price Elasticity of Demand (PED) measures the responsiveness of the quantity demanded of a good to changes in its price. It helps us understand how sensitive consumer demand is to price changes. The formula for calculating PED is as follows:

PED = (% Change in Quantity Demanded) / (% Change in Price)

Now, let's explore the relationship between PED and revenue concepts:

1. Elastic Demand (PED > 1):
   • When demand is elastic (PED > 1), a small change in price results in a relatively larger percentage change in quantity demanded.
   • If a firm lowers its price, total revenue increases because the percentage increase in quantity sold is greater than the percentage decrease in price.
   • If a firm raises its price, total revenue decreases because the percentage decrease in quantity sold is greater than the percentage increase in price.
2. Unitary Elastic Demand (PED = 1):
   • When demand is unitary elastic (PED = 1), the percentage change in quantity demanded is exactly equal to the percentage change in price.
   • A change in price has no effect on total revenue because the percentage increase in quantity sold offsets the percentage decrease in price.
3. Inelastic Demand (PED < 1):
   • When demand is inelastic (PED < 1), a change in price results in a relatively smaller percentage change in quantity demanded.
   • If a firm lowers its price, total revenue decreases because the percentage increase in quantity sold is smaller than the percentage decrease in price.
   • If a firm raises its price, total revenue increases because the percentage decrease in quantity sold is smaller than the percentage increase in price.

In summary, the relationship between PED and total revenue is as follows:

• When demand is elastic (PED > 1), price and total revenue move in opposite directions.
• When demand is inelastic (PED < 1), price and total revenue move in the same direction.
• When demand is unitary elastic (PED = 1), total revenue remains constant when prices change.

Understanding PED and its relationship to revenue concepts is crucial for businesses to make pricing decisions that maximize their total revenue and profit.