Revenue is the income generated from the sale of goods and services in a market

Average Revenue (AR) = price per unit = total revenue / output

The AR curve is the same as the demand curve

Marginal Revenue (MR) = the change in revenue from selling one extra unit of output

Total Revenue (TR) = Price per unit x quantity

The table below shows the demand for a product where there is a downward sloping demand curve.

Average and Marginal Revenue

• In the table above, as price per unit falls, demand expands and total revenue rises although because average revenue falls as more units are sold, this causes marginal revenue to decline

• Eventually marginal revenue becomes negative, i.e. a further fall in price (e.g. from £220 to £190) causes total revenue to fall.

The Relationship between Elasticity of Demand and Total Revenue

• When a firm faces a perfectly elastic demand curve, then average revenue = marginal revenue – each unit sold add the same amount to total revenue (this happens with perfect competition)

• However, most businesses face a downward sloping demand curve! And because the price per unit must be cut to sell extra units, therefore MR lies below AR.

• MR curve will fall at twice the rate of the AR curve.

You don’t have to prove this for exams – the marginal revenue curve has twice the slope of the AR curve!

Maximum Revenue

• Maximum total revenue occurs where marginal revenue is zero: no more added revenue can be achieved from producing and then selling an extra unit of output

• The point where MR=zero is directly underneath the mid-point of a linear demand curve

• When marginal revenue is zero, the price elasticity of demand = 1

• When marginal revenue is zero, if prices were cut total revenue would fall, and if prices were raised total revenue would fall

Total revenue when demand has low price elasticity (Ped < 1)

If price elasticity of demand < 1 (i.e. demand is inelastic), if prices are cut then demand rises by a smaller proportion. Cutting price when demand is relatively inelastic means total revenue falls, or MR<0

Revision Video: Maximising Total Revenue

Summary of key definitions

• Average revenue: Price per unit = TR/Q
• Marginal revenue: Change in total revenue from selling the extra unit
• Price elastic demand: When coefficient of PED > 1
• Price elasticity of demand: % change in demand for X divided by % change in price of X
• Price inelastic demand: When coefficient of PED < 1
• Price maker: A firm with pricing power because AR curve is downward sloping
• Price taker: Associated with perfect competition, where AR=MR
• Total revenue: TR = Average revenue x output
• Unitary elasticity: When the coefficient of PED = 1