Marginal revenue is the extra money made from selling an additional good. Let’s say that when you sell 100 products, your company makes $200 in total revenue, and when you sell 110 products, you make $220 in total revenue. Your marginal revenue is then equal to $2 by multiplying $20 (the additional revenue) by 10 (the additional production).
We discovered in Unit 2 that the equilibrium price of a good decreases as the supply of that good rises. However, the industry as a whole is only a very small portion of one firm in pure competition. The quantity sold by this one company will therefore have a negligible impact on the price. The purely competitive firm in the aforementioned example raises its quantity sold from 100 to 110. We can assume that the price will remain at $2 if the other businesses in the industry do not significantly increase the quantity they supply to the market. Keep in mind that if the price remains constant, the average and marginal revenues will both equal the price.
Here is a hypothetical company’s table with options for selling quantities ranging from 0 to 130. The product’s price is constant at $2. Therefore, average and marginal revenue are $2, as well. Using 110 units as an example, the total revenue is 110 times $2, or $220. The marginal revenue is calculated by dividing the change in total revenue by the variation in quantity. When the quantity is 110, the total revenue changes by $20 (compared to the previous quantity of 100), and the quantity changes by 10 (110 minus 100), so the marginal revenue is $20 divided by 10, or $2. The average revenue is calculated by dividing the total revenue by the quantity produced. For instance, the total revenue at a quantity of 120 is $240. Therefore, $240 divided by 120 equals $2, which is the average profit at this quantity.
We can create the following marginal and average revenue curve by plotting the quantities, marginal revenue, and average revenue points from the table above. The marginal and average revenue curves are equal because the price is constant. The MR and AR curves and the demand curve (D) of a purely competitive firm are identical.
Calculate Average Revenue (AR) and Marginal Revenue (MR) :
Why is the average revenue formula important?
To analyze and forecast their revenue, many businesses use the average revenue formula. ARPU can be used on a monthly basis by telecommunications companies, including mobile phone carriers. To determine and monitor the revenue generated for each cell phone user, they use the average revenue formula. Additionally, cable companies figure out ARPU for their subscribers and use that information internally, externally, in comparisons with other businesses, and for estimating future revenue. Social media platforms use average revenue to track sources of income, explain valuation discrepancies, and report to investors.
What is average revenue?
The mathematical average of revenue received per unit or per user is known as average revenue. The average revenue per unit or user (ARPU) enables a company’s management team or investors to assess revenue generation potential and project future growth. Analysts and management can benefit from ARPU as a macro-level measurement tool, but it doesn’t give them a lot of specific information about the units or user base.
When a business only sells one product at a set price, the product’s price serves as the average revenue for all of its products. Consequently, the terms “price” and “average revenue” are often used interchangeably. However, the average revenue is a way to calculate a company’s profits when it sells two or more products at two or more prices. In this instance, ARPU essentially represents the average cost per unit or user.
Total revenue and marginal revenue are two additional concepts that are closely related to average revenue. For clarity, it’s helpful to understand the differences between these terms. Here are their definitions:
What is the average revenue formula?
By dividing the total revenue by the number of units or users during a given time period, you can determine the average revenue of a unit or user. In order to provide the most accurate calculation possible, the number of units or users is estimated, or a weighted average is used, because the number of units or users can vary throughout the specified time period. We can display ARPU as a monetary sum, a table, or a curve.
The average revenue formula is:
AR = TR / Q
Where:
AR = Average revenue
TR = Total revenue
Q = Quantity of units or users
Average revenue and market structure
One of the four market structures—perfect competition, monopoly, monopolistic competition, and oligopoly—determines the relationship between the volume of goods produced and average revenue. The average revenue in a business with perfect competition is equal to the price and the marginal revenue. The average revenue in the other three market structures exceeds the price and the marginal revenue. Price and marginal revenue will decrease as output volume increases, demonstrating the company’s market control.
How to calculate average revenue
Here are the steps for calculating average revenue:
1. Collect your data
Gather a set of data over a predetermined amount of time. For instance, in order to determine the average revenue per unit for the most recent week, a business would need to know the total weekly revenue from unit sales. The revenue information might appear as follows if it sold four units in the previous week:
Unit 1 = $10,000
Unit 2 = $15,000
Unit 3 = $8,000
Unit 4 = $12,000
2. Add the data points
You must add the four unit amounts together in order to calculate the total revenue amount and enter it into the formula:
$10,000 + $15,000 + $8,000 + $12,000 = $45,000
3. Divide by the number of data points
For this example, there are four data points, one for each unit. You can enter the $45,000 in total revenue as well as the four data points into the formula for average revenue to determine the following:
AR = TR / Q
AR = $45,000 / 4
AR = $11,250
4. Analyze the results
The business now understands that the previous week’s average revenue per unit (ARPU) was $11,250. They can make forecasts or further analyze its revenue using this information.
Example
Here is an illustration of how to compute ARPU using the average revenue formula:
A software company offers various monthly subscriptions at various prices. For the purpose of calculating the revenue value for each new user, the software company wants to calculate ARPU. They can compare the revenue value of each new subscription user using this data to ascertain which of their monthly subscriptions has the greatest revenue-generating potential. They can monitor their annual growth progress using the ARPU data as well.
For the most recent quarter, the software company’s total revenue was $8. 2 million. Although there were frequent fluctuations in the number of subscriptions for the past quarter, the weighted average was 110,500 users. The business enters this data into the formula and determines the ARPU:
AR = TR / Q
AR = $8.2 million / 110,500
AR = $74.21 per user
The software provider now understands that each new subscription user generates $74 in revenue. 21. This data can be used by the business to track annual growth, calculate profits, or forecast sales.
FAQ
What is average revenue and its formula?
Total revenue / the number of units or users equals average revenue. All of the money a business makes over a certain time period is referred to as revenue. By using the average revenue formula, businesses can determine useful information about revenue, which is equivalent to calculating the mathematical average of any set of numbers.
What is the average revenue example?
Average revenue is revenue per product. For instance, if your company makes $200 in total revenue and you sell 100 products, your average revenue is $2 ($200 divided by 100).
How do you calculate average revenue and marginal revenue?
Divide the total revenue by the number of units sold to get the average revenue. Because it stays constant across other varying output levels, the price of a competitive firm equals both its marginal revenue and average revenue.
How do you find average revenue from demand function?
Divide the total revenue by the number of units sold to get the average revenue. Because it stays constant across other varying output levels, the price of a competitive firm equals both its marginal revenue and average revenue.
