Now is the time to create some technical ideas that will aid in future analysis. The first of these is the concept of elasticity. Up until this point, we’ve described the contours of the supply and demand curves in terms of their slopes. It is not always useful to categorize curves as flat or steep because how steep or flat a curve appears depends on the units used to measure price and quantity. Figure 1 displays the demand curve’s slope. Let Δ represent the words “small change”. The demand curve’s slope, represented by the Greek letter, can then be expressed as 1. Measure the number of eggs in dozens and the cost of the eggs in dollars with the formula: = P / Q. If, say, a rise in price of $1. As we move up the demand curve, 00 reduces egg consumption by 5 dozen, so the slope will be -0. 2.
Imagine that we continue to measure the amount in eggs and the cost in dollars. The demand curve will now be flatter, resulting in a $1 price increase. 00 will result in a 60 egg reduction in egg consumption, giving a slope of -0. 016667. The slope of this same demand curve would be -100/5 = -20 if, instead, we were to measure the price of eggs in cents and the quantity of eggs in dozens. The distance between the units of price and quantity along the axes will also affect the curve’s apparent slope; for example, if the quantity units are placed a quarter of an inch apart, the curve will appear steeper than if they are placed half an inch apart.
We avoid this reliance on units of measurement by measuring the responsiveness of quantity to price changes using the concept of elasticity. The relative change in quantity (or percentage change) divided by the relative change in price (or percentage change) is known as the elasticity of demand. Let’s use the Greek letter to represent the demand elasticity Then we can write.
The elasticity is equal to the slope’s reciprocal times the ratio of price to quantity. Figure 2, which compares the demand elasticity to the initial price-quantity combination (P0,Q0), illustrates all of this. It turns out that as we move along the curve, the elasticity will change. Equation 4 should make this abundantly clear: for a constant slope, the straight-line demand curve’s elasticity will decrease as P/Q declines as we move down to the right; at the vertical axis, where Q is zero, the elasticity is infinite, and at the quantity axis, where P is zero, the elasticity is zero.
The elasticity of supply is calculated exactly like the elasticity of demand, as shown in Figure 3 below, with the exception that supply’s elasticity is positive while demand’s is negative, reflecting the fact that the supply curve is upward sloping and the demand curve is negatively sloped. As shown in the figure, we measure the elasticity in relation to the initial price-quantity combination (P0, Q0) and denote the slope of the supply curve by. A straight supply curve will not have constant elasticity unless it passes through the origin, in which case the slope and the ratio P/Q will both be constant.
By multiplying the price by the quantity, the total revenue to the seller of a good or service, or the total cost to the buyer, is determined. It can be seen in Figure 4 as the area of a rectangle whose top right corner is a point on the demand curve and whose bottom left corner is the origin. Price and quantity are equal in the top left and bottom right corners, respectively. For instance, Figure 4’s shaded rectangle displays total revenue at point c on the demand curve, which is the result of the product of the price P0 and the quantity Q0. The rectangle P1 a Q1 0 represents the total revenue at point a.
The total revenue varies as we move along the demand curve, which is also evident in the aforementioned Figure. At zero quantity and price Pm, the overall profit is zero. The total revenue rises as we descend the demand curve, reaching its peak at point b (the midpoint between the two ends of the curve), before falling and returning to zero at price zero and quantity Qm.
The inverted parabola 0 g m h Qm is used in the Figure to represent total revenue; it is measured on a different vertical axis than price, of course. The distance h Q0 is equal to the shaded area P0 c Q0 0. In a similar manner, the distance between m and the horizontal axis when viewed perpendicularly equals the area of the rectangle under the demand curve at point b. Additionally, the distance g Q1 is equal to the area of the rectangle under the demand curve at point a.
where TR is total revenue. Thus, the slope of the total revenue curve in Figure 5 represents the marginal revenue. Selling the first unit increases total revenue by one time the unit’s price, since the marginal revenue is equal to the price at quantity zero. Because the price of each successive unit is lower than the price of the one before it and because all previous units must be sold at this lower price as the quantity grows, the marginal revenue declines.
Figure 5 displays the margin of profit for each quantity sold as the distance between the thick line and the horizontal axis at that quantity. This distance corresponds to the total revenue curve’s slope at that quantity. The slope of the total revenue curve is zero at the point of maximum total revenue m, and as a result, the marginal revenue is also zero at this point. The quantity at which the total revenue is at its maximum is where the marginal revenue curve thus crosses the horizontal axis. This occurs at the midpoint of the demand curve, where the horizontal axis bisects the distance 0 Qm, when the demand curve is a straight line. A straight-line demand curve’s midpoint is where the marginal revenue turns negative.
The best way to explain the significance of marginal revenue is with an example. Consider the market for fresh eggs in a locality. Assume that the government gives producers permission to create an Egg Marketing Board that has the authority to decide how much consumers will pay for eggs and how much output each producer will receive. Purchases of eggs from outside the local area are prohibited. This situation is shown in Figure 6. The line DD represents the supply curve, and the horizontal line C0S represents the demand curve. Given that most of the inputs needed to produce eggs can be purchased by egg producers at fixed market prices—these inputs are also used by other industries, and egg producers only consume a small portion of the available supply—a horizontal supply curve is a reasonable assumption here. This suggests that the cost of hatching and raising chicks into hens is constant.
The shaded area in Figure 6 shows the profit that results from this arrangement for egg producers, who can sell their eggs to consumers for a price higher than what it costs to produce the eggs. The issue the Marketing Board faces when speaking on their behalf is figuring out the quantity to purchase in order to maximize that profit. A higher price at a lower output quota results in a profit, but producers will sell fewer goods overall.
The profit is the difference between total revenue, as indicated by area P1 a Q1 0, and total cost, as indicated by area C0 b Q10. The Board’s challenge is to determine whether to raise the output quota by one unit at each quota level. It will do this if the marginal revenue—the additional money made from selling another unit to customers—is higher than the marginal cost—the additional money spent on producing another unit.
The thick line in Figure 6 indicates the marginal revenue. The horizontal supply curve alone provides the marginal cost, with each additional unit produced increasing the total cost by 0 C0. Therefore, the Board will begin at zero and gradually increase the quota until the marginal revenue curve crosses the marginal cost curve (in this instance, the supply curve). Output will expand until marginal revenue equals marginal cost. The profit to egg producers will be maximized at this output level.
Beginning with output Q1 in Figure 6, if the Board were to increase the output quota by one more unit, the increase in total revenue from sales of that additional unit would be less than the increase in the total cost of production, making such an expansion of the quota unjustifiable. Instead, if the quota were cut by one unit, the total revenue lost from selling one fewer unit would be greater than the total cost savings from producing one fewer unit, rendering the quota cut ineffective. By adjusting the quantity sold to balance marginal cost and marginal revenue, profits are maximized.
Despite the fact that the elasticity of demand is actually negative, economists have a convention of referring to it as positive. When people refer to a demand elasticity greater than 1, they actually mean a demand elasticity less than -1. They are referring to the demand elasticity’s absolute value. The algebraic value of -2 is -2, while its absolute value is 2. By merely ignoring a number’s sign, we can determine its absolute value. Therefore, when economists say that a demand is highly elastic, they mean that the elasticity is a significant number with a minus sign.
Total revenue, average revenue and marginal revenue
What is a total revenue test?
To calculate the price elasticity of demand, the total revenue test is employed. A type of economic measurement known as the price elasticity of demand is used to assess how the demand for a product changes in relation to its price. This measurement is frequently used to better comprehend how supply or demand fluctuates in response to price changes. Total revenue tests are used by businesses to develop a pricing strategy that best satisfies customer demand for their good or service.
The business will approach pricing with caution if the total revenue test reveals that demand for a good or service is exceptionally elastic because even small price changes can lead to a drop in demand and, ultimately, a drop in total revenue. When total revenue tests reveal that demand is inelastic, businesses can change prices more frequently with little to no impact on the level of demand for the good or service.
What is total revenue?
Total revenue refers to the sum of money a business earns from selling its goods or services over a specific time period. This amount is typically calculated by dividing the cost of goods sold by the company.
The majority of businesses concentrate on increasing the gap between their overall cost of producing goods and their overall revenue from selling those goods. It is possible for marketing and business managers to develop business plans that increase production by being able to distinguish between cost and revenue. Higher total revenues as a result of higher production translate into more money for the business.
There are a few key factors that affect total revenue. These factors include:
What is marginal revenue?
A rise in revenue as a result of selling one more unit of output is referred to as marginal revenue. Typically, marginal revenue changes gradually in response to rising output levels. However, because of the law of diminishing returns, the increase in marginal revenue will be slower as a company produces more output.
Companies will keep increasing output until the marginal cost equals the marginal revenue if they want to maximize their profits. Companies typically conduct a cost-benefit analysis and halt product production when marginal revenue is less than marginal cost.
Competitive companies typically have marginal revenues that are consistent. This is because the market chooses the best price level, and businesses have little control over how much a good or service will cost. When the marginal costs are equal to the marginal revenue and market price of a good or service, competitive businesses take advantage of this to their advantage and enjoy maximized profits.
How do companies use total revenue?
Businesses use total revenue to gauge the health of their overall business. Prior to any other type of revenue or sales, they place total revenue as the first line on an income statement. This kind of revenue demonstrates to businesses the amount of money they are making from the sale of their products or services.
Additionally, businesses use total revenue to gauge the effectiveness of their marketing initiatives. Reduced total revenue frequently indicates that marketing efforts are not as successful as they could be. On the other hand, growing revenue frequently indicates that a business’ marketing strategy is being successfully implemented.
Additionally, companies can assess how changes in pricing affect the demand for their product using total revenue. For instance, if a business raises its prices while seeing a decline in total revenue, this is frequently a sign that the demand for the product is not as high as the business anticipated. However, if a business raises its prices and its overall revenue does too, this typically indicates that there is strong demand for the product.
Differences and similarities between total revenue and marginal revenue
When gaining insight into a company’s success, total revenue and marginal revenue are two of the most frequently used types of revenue. Total revenue is the total amount of money made from selling goods and services, whereas marginal revenue is the additional money made from selling one more unit of a good or service. Since it represents the additional revenue generated from the sale of an additional unit, marginal revenue is directly related to total revenue.
The total revenue will keep rising as long as the marginal revenue exceeds the marginal cost of producing a new unit. Companies frequently experience a decline in total revenue when the marginal cost exceeds the marginal revenue.
While both types of revenue are related to a company’s overall earnings, they differ in that marginal revenue only refers to the measurement of increased earnings when selling an additional good or service, whereas total revenue is the sum of all sales. In other words, any additional total revenue generated by increasing sales by one unit is known as marginal revenue.
How to calculate total revenue
Companies use the following formula to calculate total revenue:
For instance, if a business sells ten pairs of shoes for a total of $50, the total revenue is $500 (50 x 10 = 500).
How to calculate marginal revenue
The following is the formula used to calculate marginal revenue:
For instance, if a business produces 100 pairs of shoes and sells them for $150 each, it will earn a total of $15,000 in sales. The business drops the cost of each pair of shoes to $149 in order to produce an additional 1,000 pairs. As a result, the business’ marginal revenue is $49 ($15,049 less $15,000 divided by 1 = $49).
FAQ
What is the relationship between TR and MR?
TR rises as long as MR is positive (or vice versa: MR is positive as TR rises). ADVERTISEMENTS: 2. TR reaches its maximum point when MR is zero (or vice versa; when TR reaches maximum, MR is zero).
Does total revenue equal marginal revenue?
By dividing the change in total revenue by the change in total output volume, a business determines its marginal revenue. Therefore, marginal revenue is equal to the sale price of one additional item sold. As an illustration, a business sells its first 100 products for a total of $1,000.
Is total revenue the same as marginal cost?
Since it represents the additional revenue generated from the sale of an additional unit, marginal revenue is directly related to total revenue. The total revenue will keep rising as long as the marginal revenue exceeds the marginal cost of producing a new unit.
What is the difference between marginal revenue and total revenue quizlet?
What separates marginal revenue from total revenue is a change in total revenue divided by a change in quantity, whereas total revenue is the sum of all sales.
