Revenue The other part of the equation!
Objectives • Explain the difference between Average, Marginal and Total Revenue • Draw these lines graphically • Explain the implications for a firm’s profit making decisions
Outcomes • A: To have drawn the three types of revenue curves • M: To understand clearly where these are derived from • S: Be able to make the link between these revenue, cost and profit situations
Back to Basics • Profit is represented by the Greek letter ∏ Pi • Profit = Total Revenue – Total Cost
Total Revenue • This is the firms total earnings from sales of a product • TR= PxQ
TR
Average Revenue • The amount earned per unit sold • AR = TR/Q • So if the firm earns £5000 from 1000 units then AR = £5 • But this is simply the price!
AR
Marginal Revenue • This is the additional total revenue from selling one more unit. • MR = ∆TR/ ∆Q. • So if the firm sells 20 extra units for a total of £100 then MR = £5
MR
Constructing the curves for a price maker • Assume the firm faces a downward sloping demand curve. • It has some control over the price it charges.
Q 1
P £ TR £ 8
2
7
3
6
4
5
5
4
6
3
7
2
MR £
AR £
Constructing the curves for a price maker • Assume the firm faces a downward sloping demand curve. • It has some control over the price it charges.
Q 1
P £ TR £ 8 8
MR £ 8
2
7
14
6
3
6
18
4
4
5
20
2
5
4
20
0
6
3
18
-2
7
2
14
-4
AR £
What sort of business would this be? • Monopoly • Limited Competition • Differentiated products
Price Taker • What sort of business would have no control over price at all? • Perfectly Competitive
Conditions facing a price taker Q
P£
0
5
1
5
2
5
3
5
4
5
5
5
6
5
TR £
MR £
Conditions facing a price taker Q
P£
TR £
MR £
0
5
0
5
1
5
5
5
2
5
10
5
3
5
15
5
4
5
20
5
5
5
25
5
6
5
30
5
Why is the MR curve not the Demand Curve?
Objectives • Emphasise link between MR and AR • Clarify any confusion! • Relate to price making businesses.
Outcomes • All will understand the reasons for AR representing a price makers demand curve • All will have drawn accurate diagrams representing the AR and MR curves.
Recap • Marginal means the change in total caused by one additional unit • Average is the total divided by the number of units
AR and MR curves
Average Revenue
Marginal Revenue
Another Table! Quantit y 1
Price
TR
10
10
MR
8 2
9
18 6
3
8
24 4
4
7
28 2
5
6
30 0
6
5
30 -2
Quantit y 1
Price
TR £
= AR£ 10
10
MR £
8 2
9
18 6
3
8
24 4
4
7
28 2
5 6 7
6 5 4
The business wants to increase its sales so cuts price to £9. This means it sells another unit for £9. BUT it has also had to sell the first one at £9 as well! It would have been able to sell this for £10 before.
0
So the total change to revenue is +£9 from the second unit but -£1 from having to discount the first.
-2
MR = £8
30 30 28
Suppose Price is currently £10, 1 unit will sell.
Got it?? • The AR curve is still the demand curve and the MR curve simply shows the change in revenue form the last unit.
Elasticity Elastic
Inelastic
Average Revenue
Marginal Revenue
You what??? • Remember elasticity measures the relationship between price and quantity demanded • If D is elastic then a fall in price will lead to a larger increase in demand and as a result revenue will rise. • If D is inelastic a fall in price will cause a less than proportional increase in demand and revenue will fall.
Elasticity Elastic
Inelastic
Average Revenue
Marginal Revenue