3.3.1 Revenue

Question 1

Revenue

Question 2

Total Revenue (TR)

Answer 2

The total amount of money coming into the business through the sale of goods/services
Quantity x Price

Question 3

Average Revenue (AR)

Answer 3

AR = Demand (D)
= Total Revenue / Output

Question 4

Marginal Revenue (MR)

Answer 4

The extra revenue that the firm earns from selling one more unit of production
Change in total revenue / Change in output

Question 5

Price elasticity of demand and its relationship to revenue concepts (relationship between PED and TR)

Answer 5

• Some firms experience a perfectly elastic demand curve; these are firms in perfect competition, a concept looked at in the next unit. These firms have no price setting power. In this case, the price received by the firm for the good is constant and so MR=AR=D. Their demand curve is horizontal. The TR curve is upward sloping because prices are constant and so the more goods that are sold, the higher the revenue made.
• However, for most goods, the price decreases as output increases and there is a downward sloping demand curve and therefore a downward sloping AR curve. The demand curve for the firm is the same as the firm’s AR revenue curve, as it indicates the price that consumers are willing to pay for each quantity sold. Firms with a downward sloping demand curve are firms that are in imperfect competition and so they have some price setting power.

Question 6

Pricing decisions to increase TR ???

Answer 6

Elastic Opposite
- To increase TR when demand is elastic, decrease price
Inelastic Opposite
- To increase TR when demand is inelastic, increase price

Question 7

PED relationship with MR - downward sloping curve

Answer 7

For goods with a downward sloping demand curve, the elasticity of the curve is linked to marginal revenue. In Theme 1, we ignored that the price elasticity of demand changes along the demand curve. The concept of price elasticity and revenue learnt in Theme 1 can be developed and connected to MR in this unit:
• If marginal revenue is positive, when the firm sells the product at a lower price (or when they increase output), total revenue still grows and so the demand curve is elastic. Up until output Q, the demand curve is elastic.
• If MR is negative, TR decreases as price decreases (or output increases) and so the demand curve is inelastic. After output Q, the demand curve is inelastic.
• When MR=0, TR is maximised and the demand curve is unitary elastic; this is at point Q.
- This explains why the TR curve is a U-shape: at first, total revenue rises with output (when MR is positive) but it then begins to decline (when MR is negative).