9:36
Y2 7) Revenue - MR, AR & TR
EconplusDal
Overview
This video explains the fundamental concepts of total revenue (TR), average revenue (AR), and marginal revenue (MR) in economics. It details how these revenue measures are calculated and how their corresponding curves are shaped under two distinct market structures: perfect competition and imperfect competition. The explanation highlights the key differences in revenue curves based on whether firms are price takers or price makers, and it connects these concepts to the law of demand and profit maximization.
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Chapters
- Total Revenue (TR) is calculated by multiplying the price of a good by the quantity sold (P x Q).
- Average Revenue (AR) is total revenue divided by the quantity sold, which simplifies to the price of the good (TR / Q = P).
- Marginal Revenue (MR) is the additional revenue gained from selling one more unit of a good (Change in TR / Change in Q).
Understanding these basic revenue calculations is crucial for analyzing a firm's financial performance and making informed pricing and production decisions.
If a business sells 10 items at $5 each, its total revenue is $50 (10 * $5). The average revenue per item is $5 ($50 / 10), and if selling the 11th item brings total revenue to $53, the marginal revenue is $3 ($53 - $50).
- Perfect competition is a theoretical market with many buyers and sellers, identical products, no barriers to entry/exit, and perfect information.
- Firms in perfect competition are price takers, meaning they must accept the market price.
- Consequently, AR and MR are constant and equal to the market price, forming a horizontal line.
- Total Revenue (TR) increases linearly with quantity because the price remains constant.
This scenario illustrates a baseline for revenue generation where firms have no pricing power, simplifying revenue analysis and highlighting the impact of market forces.
In a perfectly competitive market where the price is $1 per unit, a firm selling 1, 2, 3, 4, or 5 units will have AR and MR of $1 for each unit, and its TR will be $1, $2, $3, $4, and $5 respectively.
- Imperfect competition (like monopolies or oligopolies) features fewer sellers, differentiated products, barriers to entry, and imperfect information.
- Firms are price makers and must lower their price to sell more units, adhering to the law of demand.
- Average Revenue (AR) is equal to the price and slopes downward, mirroring the demand curve.
- Marginal Revenue (MR) also slopes downward but is steeper than AR and can become negative.
- TR initially rises, peaks, and then falls as MR becomes negative.
This market structure is more realistic for most businesses, showing how pricing decisions impact revenue and how firms must navigate the trade-off between price and quantity sold.
If a firm sells 5 units at $6 each (TR=$30), and then lowers the price to $5 to sell 6 units (TR=$30), the MR is $0 ($30-$30). If it lowers the price to $4 to sell 7 units (TR=$28), the MR is -$2 ($28-$30).
- In imperfect competition, the Average Revenue (AR) curve is identical to the market demand curve because AR is simply the price at each quantity.
- The Marginal Revenue (MR) curve is always below the AR curve and is twice as steep.
- This steeper slope for MR occurs because lowering the price to sell an additional unit reduces revenue not only on that unit but also on all previously sold units.
- Total Revenue is maximized at the quantity where Marginal Revenue (MR) equals zero.
Understanding the geometric relationship between AR, MR, and demand is key to visualizing how revenue changes with output and identifying the point of maximum total revenue.
If the demand (and AR) curve is represented by P = 10 - Q, the MR curve will be MR = 10 - 2Q. TR is maximized when MR = 0, which occurs at Q=5.
Key takeaways
- Revenue is generated from sales and is broken down into total, average, and marginal components.
- In perfect competition, firms are price takers, leading to horizontal AR and MR curves equal to the market price.
- In imperfect competition, firms are price makers, resulting in downward-sloping AR (demand) and MR curves that are steeper than AR.
- Marginal revenue can become negative in imperfect competition, indicating that selling more units decreases total revenue.
- Total revenue is maximized when marginal revenue is zero; beyond this point, selling more units reduces total revenue.
- The AR curve in imperfect competition directly represents the market demand curve.
- The mathematical relationship between AR and MR in imperfect competition is that MR is twice as steep as AR.
Key terms
Total Revenue (TR)Average Revenue (AR)Marginal Revenue (MR)Perfect CompetitionImperfect CompetitionPrice TakerPrice MakerHomogeneous GoodsDifferentiated GoodsLaw of Demand
Test your understanding
- How does the calculation of marginal revenue differ from average revenue?
- Why are firms in perfect competition considered price takers, and what does this imply for their revenue curves?
- Explain the relationship between the average revenue curve and the demand curve in imperfect competition.
- What is the economic reason why marginal revenue is steeper than average revenue in imperfect competition?
- Under what condition is total revenue maximized, and why does this occur at that specific point?