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Having studied costs we now turn to the income that businesses generate from selling their output of goods and services in markets – business revenues. The meaning of revenue Revenue (or turnover) is the income generated from the sale of output in product markets. There are two main revenue concepts to grasp at this stage:
The table below shows the demand for a product where demand varies inversely with the price.
Average and marginal revenue – the important relationships In our example in the table above, as price per unit falls, demand expands and so too does total revenue, although because the demand curve is downward sloping, the average revenue falls as more units are sold. This causes marginal revenue to decline. Eventually once marginal revenue becomes negative, a further fall in price (e.g. from £220 to £190) causes total revenue to fall. Because the price per unit is declining, total revenue is rising at a decreasing rate and will eventually reach a maximum (see the next paragraph). Elasticity of demand and total revenue When a firm faces a perfectly elastic demand curve, then average revenue = marginal revenue (i.e. extra units of output can all be sold at the ruling market price). 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. In fact he MR curve will fall at twice the rate of the AR curve. You don’t have to prove this for the exams – but it is worth remembering that the marginal revenue curve has twice the slope of the AR curve! The total revenue for any business is maximised when marginal revenue (MR) = zero. Once MR becomes negative, total revenue falls if extra units are sold. This is shown in the next diagram.
Total revenue is shown by the area underneath the firm’s demand curve (average revenue curve).
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| Author: Geoff Riley, Eton College, September 2006 | ||||||||||||||||||||||||||||||||||||||||
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