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Meaning and Types of Markets

Concepts of Total Revenue Average Revenue and Marginal Revenue

There are four major market types namely, perfect competition, monopoly, monopolistic competition, and oligopoly. Before you understand these market forms, it is important to know the concepts of total revenue, average revenue, and marginal revenue. In this article, we will clarify these concepts with the help of some examples and look at the behavioral principles.

Total Revenue

A firm sells 100 units of a particular commodity for Rs. 10 each. If you were to calculate the amount realized by the firm, the answer is simple – Rs. 1,000 (100 x 10). This is the total revenue for the firm.

Hence, the total revenue refers to the amount of money realized by a firm on the sale of a commodity. Total revenue is expressed as follows:

TR = P x Q … where TR – Total Revenue, P – Price, and Q – Quantity of the commodity sold.

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Average Revenue

Average revenue is simply the revenue earned per unit of the output. In simpler words, it is the price of one unit of the output. Average revenue is expressed as follows:

$$AR =  \frac {TR}{Q}$$ … where AR – Average Revenue, TR – Total Revenue, and Q – Quantity of the commodity sold.

By using the formula for total revenue, we get

$$AR = \frac {P × Q}{Q}$$ Or AR = P

For example, a firm sells 100 units of a commodity and realizes a total revenue of Rs. 1,000. Therefore, its average revenue is

$$AR = \frac {1000}{100}= Rs. 10$$

Hence, the firm sells the commodity at a price of Rs. 10 per unit.

Marginal Revenue

Marginal revenue (MR) is the change in total revenue resulting from the sale of an additional unit of a commodity.

For example, consider a firm selling 100 units of a commodity and realizing a total revenue of Rs. 1,000. Further, it realizes a total revenue of Rs. 1,200 after selling 101 units of the same commodity. Therefore, the marginal revenue is Rs. 200.

Marginal revenue is also defined as the rate of change of total revenue resulting from the sale of an additional unit of a commodity.

Therefore,

$$MR = \frac {ΔTR}{ΔQ}$$ … where MR – Marginal revenue, TR – Total revenue, Q – Quantity of the commodity sold, and Δ – the rate of change.

Further, for one unit change in output, we have

MRn = TRn – TRn-1

Where,

  • TRn – the total revenue when the sales are at the rate of ‘n’ units per period.
  • TRn-1 – the total revenue when the sales are at the rate of (n-1) units per period.

marginal revenue

Marginal Revenue, Average Revenue, Total Revenue and the Elasticity of Demand

It is important to note that the marginal revenue, average revenue and price elasticity of demand are related to one another through the following formula:

$$MR = AR×\frac {e – 1}{e}$$ … where ‘e’ is the price elasticity of demand.

Further,

  • If e = 1, then $$MR = AR×\frac {1 – 1}{1}= 0$$
  • If e > 1, then MR is positive.
  • If e < 1, then MR is negative.

Behavioural Principles

Principle 1

“A firm should not produce at all if total revenue from its product does not equal or exceed its total variable cost.”

Explanation: A firm produces products for profits. Therefore, if a firm does not better by producing certain products, then it should rather not produce them. Remember, a firm always has an option of not producing anything. In a zero production scenario, the firm will have an operating loss equal to its fixed costs. If the production adds more cost than revenue to the firm, then it increases the loss of the firm.

Principle 2

“It is profitable for the firm to increase the output whenever the marginal revenue is greater than the marginal cost. Ideally, the firm must continue expanding until the marginal revenue equals the marginal cost. Also, apart from being equal, the marginal cost curve must cut the marginal revenue curve from below.”

Explanation: According to this principle, if a unit of production adds more to the revenue than to the cost, then the said unit increases the profits of the firm. On the other hand, if it adds more to the cost than to the revenue, then the unit decreases the profits of the firm. The firm has maximum profits at the point where the additional revenue from a unit equals its additional cost.

Solved Questions on Marginal Revenue

Q1. Assume that when the price is Rs. 20, quantity demanded is 9 units, and when the price is Rs. 19, quantity demanded is 10 units. Based on this information, what is the marginal revenue resulting from an increase in output from 9 units to 10 units?

  1. Rs. 20
  2. Rs. 19
  3. Rs. 10
  4. Rs. 1

Answer: Scenario 1 – Price is Rs. 20 and the quantity demanded is 9 units. Therefore, the total revenue is

TR1 = Price x Quantity = 20 x 9 = Rs. 180.

Scenario 2 – Price is Rs. 19 and the quantity demanded is 10 units. Therefore, the total revenue is

TR2 = Price x Quantity = 19 x 10 = Rs. 190.

From the definition of marginal revenue, we know that

MRn = TRn – TRn-1

Therefore, we have

Marginal Revenue = TR2 – TR1 = 190 – 180 = Rs. 10.

Hence, the correct answer is option c – Rs. 10.

Q2. Assume that when the price is Rs.20, quantity demanded is 15 units, and when the price is Rs.18, quantity demanded is 16 units. Based on this information, what is the marginal revenue resulting from an increase in output from 15 units to 16 units?

  1. Rs. 18
  2. Rs. 16
  3. Rs. 12
  4. Rs. 28

Answer: Scenario 1 – Price is Rs. 20 and the quantity demanded is 15 units. Therefore, the total revenue is

TR1 = Price x Quantity = 20 x 15 = Rs. 300.

Scenario 2 – Price is Rs. 18 and the quantity demanded is 16 units. Therefore, the total revenue is

TR2 = Price x Quantity = 18 x 16 = Rs. 288.

From the definition of marginal revenue, we know that

MRn = TRn – TRn-1

Therefore, we have

Marginal Revenue = TR2 – TR1 = 300 – 288 = Rs. 12.

Hence, the correct answer is option c – Rs. 12.

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