BBA I Semester Managerial Economics Concepts Revenue Study Material Notes
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BBA I Semester Managerial Economics Concepts Revenue Study Material Notes: Relation Between ara and Mr. Curves under Different Market Condition Under pure Competition Under Monopoly or Imperfect competition Importance of revenue Curves Relationship Between Price Elasticity and Sales Revenue Exercises ( This Post Is Most Important For BBA I Semester Students )
MCom I Semester Corporate Accounting Valuation Shares study Material Notes
THE CONCEPTS OF REVENUE
TOTAL, AVERAGE, AND MARGINAL REVENUE
The revenue of a firm together with its costs determines profits. We, therefore, turn to the study of the concept of revenue.
The term ‘revenue’ refers to the receipts obtained by a firm from the sale of certain quantities of a commodity at various prices. The revenue concept relates to total revenue, average revenue, and marginal revenue.
Total revenue is the total sale proceeds of a firm by selling a commodity at a given price. If a firm sells 2 units of a commodity at Rs. 18, total revenue is 2 x 18 =Rs. 36. Thus total revenue is price per unit multiplied by the number of units sold, i.e., R=PxQ, where R is the total revenue, P the price and the quantity.
Average Revenue (AR or A) is the average receipts from the sale of certain units of the commodity. It is found out by dividing the total revenue by the number of units sold. In our above example, average revenue is 36:2=Rs.18. The average revenue of a firm is, in fact, the price of the commodity at each level of output. Since
R= PxQ .
A=R/Q=PxQQ=P
and P=f(Q)
Thus the functional relationship P=fQ) is the average revenue curve which reflects price as a function of quantity demanded. It is also the demand curve.
Marginal revenue (MR or M) is the addition to total revenue as a result of a small increase in the sale of a firm. Algebraically, M is the addition to R by selling n + 1 units instead of n units. M=dR/dQ, where d represents a change.
Since we are concerned mainly with the relationship between average revenue and marginal revenue, we ignore total revenue in our discussion. The relationship between average revenue and marginal revenue under pure competition, monopoly and other market situations is discussed below.
RELATION BETWEEN ARAND MR CURVES UNDER DIFFERENT MARKET CONDITIONS
The relation between average revenue and marginal revenue can be discussed under pure competition, monopoly or monopolistic competition or imperfect competition.
(1) Under Pure Competition
The average revenue curve is a horizontal straight line parallel to the X-axis and the Curve coincides with it. This is because under pure (or perfect) competition marginal revenue curve coincides with it. This is be selling an identical product is very large. The price is determined by the the number of firms selling an identical product is very market forces of supply and demand so that only one price tends to prevail for the whole industry, as shown in shown in panel (A) of Each firm can sell as much as it wishes at the market price OP.
Thus the demand for the firm’s product becomes infinitely elastic. Since the demand curve is the firm’s average revenue curve, the shape of the AR curve is horizontal to the X-axis at price OP, as shown in panel (B) and the MR curve coincides with it. This is also shown in Table 1 where AR and MR remain constant at Rs 20 at every level of output. Any change in the demand an supply conditions will change the market price of the product, and consequently the horizontal AR curve of the firm.
(2) Under Monopoly or Imperfect Competition
The average revenue curve is the downward sloping industry demand curve and its corresponding marginal revenue curve lies below it. The relation between the average revenue and the marginal revenue under monopoly can be understood with the help of Table 2. The marginal revenue is lower than the average revenue. Given the demand for his product, the monopolist can increase his sales by lowering the price, the marginal revenue also falls but the rate of fall in marginal revenue is greater than that in average revenue. In Table 2, AR falls by Rs. 2 at a time whereas MR falls by Rs. 4. This is shown in Figure 2, in which the MR curve is below the AR curve and lies halfway on the perpendicular drawn from AR to the Y-axis. This relation will always exist between straight-line downward sloping AR and MR curves.
In order to prove it, draw perpendiculars CA and CM to the Y-axis and X-axis respectively from point Con the AR curve, CA cuts MR at B and CM at D. We have to prove that AR = BC. In Figure 2, the rectangle ACMO is the total revenue of OM output at CM price and the area PDMO also represents total revenue in terms of aggregate marginal revenue (SMR) at OM output. ..
4. Under Oligopoly
The average and marginal revenue curves do not have a smooth downward slope. They possess kinks. Since the number of sellers under oligopoly is small, the electoral Price increase on the part of one seller will be followed by some changes in the behavior of other firms. If a seller raises the price of his product, the other seller’s wine follows him in order to earn large profits at the old price. So the price-raising seller will experience a fall in the demand for his product. His average revenue curve in Figure /(A) becomes elastic after K and its corresponding MR curve rises discontinuously from a to band then continues its course at the new higher level.
On the other hand, if the oligopolistic seller reduces the price of his product, his rivals also follow him in reducing the prices of their products so that he is not able to increase his sales. His AR curve becomes less elastic from Konwards as in Figure 7(B). The corresponding MR curve falls vertically from a to b and then slopes at a lower level.
IMPORTANCE OF REVENUE CURVES
The concept of revenue has great significance in different areas.
1 Profit Determination. The AR and MR curves form important tools for economic analysis. The AR curve is the price line for the producer in all market situations. By relating the AR curve to the AC curve of a firm, it can be found out whether it is earning supernormal or normal profits or incurring losses.
(i) If the AR curve is tangent to the AC curve at the point of equilibrium, the firm earns normal profits.
(ii) If the AR curve is above the AC curve, it makes supernormal profits.
(iii) In case the AR curve is below the AC curve at the equilibrium point, the firm incurs losses.
2. Determination of Full Capacity. It can also be known from their relationship whether the firm is producing at its full capacity or under capacity. If the AR curve is tangent to the AC curve at its minimum point, (as under perfect competition, the firm produces at its full capacity. Where it is not so (as under monopoly or monopolistic competition), the firm possesses idle capacity.
3. Fauilibrium Determination of the Firm. The MR curve when intersected by the MC curve determines the equilibrium position of the firm under all market situations. Infect point of intersection determines price, output, profit or loss of a firm.
4. Factor Pricing. The use of the average-marginal revenue concepts helps in determining the prices of factor services. In factor pricing, they are inverted U-shaped and the average and marginal revenue curves become the average revenue product and marginal revenue productivity curves (ARP and MRP) and are useful tools in explaining the equilibrium of the firm under different market conditions.
Relationship Between Price Elasticity and Sales Revenue
The proper estimation of price elasticity is of great significance for business decision-making. A firm’s revenue changes as a result of the change in price. Total revenue (TR) earned from sales by a firm is obtained by multiplying average unit price with the total D quantity sold, i.e., TR= PxQ.
In Figure 8, the total revenue obtained from OQ quantity sold at OP price is OPCO. Here, three things are clear:
(1) If the demand price is elastic, with an increase in price, there is a large fall in sales so that the total revenue decreases. On the other hand, if the price falls, the sales increase so much that the total revenue rises.
(2) If the elasticity of demand is equal to unity, there is no change in total revenue earned from sales even with the change in price. For example, with the fall in price by 5%, Quantity Sold the sales will increase by 5% whereby the total revenue will remain unchanged.
(3) If the demand price is inelastic, the sales will fall with the increase in price but the total revenue will rise. On the other hand, with the fall in price, the sales will increase but the total revenue will fall.
In general, unity elasticity is not found in practice. When price changes in a certain ratio, the sales normally change in a high or low ratio.
Thus, if the management wants to increase sales, it has to reduce the price. But if the reduction in price is compensated by the additional sales, the total revenue will increase or remain the same. Similarly, the management can raise the price of product for increasing revenue. But if the fall in revenue as a result of sales reduction is not compensated by the increased price, the total revenue will fall. Hence, the effect of a change in price on sales determines the effect of the change in price on total revenue. Moreover, the firm often remains in a fix as to whether the sales should increase or decrease. In such a situation, the concept of marginal revenue is decisive.
EXERCISES
1 Prove that: Elasticity of Demand = Average Revenue – Marginal Revenue
2. Explain the relationship between average and marginal revenue curves and discuss their dependence on elasticity. The friendship between average revenue and marginal revenue curves
3. Explain the relationship between average revenue and marginal under perfect competition and imperfect competition.
4. Explain the relationship between price elasticity and sales revenue
