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Revenue Analysis: Total, Average and Marginal Revenue and Their Link with Elasticity
Costs show what a firm spends. Revenue analysis shows what it earns. To decide how much to produce and what price to charge, a manager needs to know how revenue changes as sales change. Let us understand the three revenue concepts and an important link between revenue and the price elasticity of demand.
Meaning of revenue
Revenue is the money a firm receives from selling its output. There are three types:
- Total revenue (TR): total money received from all units sold. TR = Price × Quantity.
- Average revenue (AR): revenue per unit sold. AR = TR ÷ Q. Since TR = P × Q, AR is equal to price. The AR curve is therefore the demand curve of the firm.
- Marginal revenue (MR): the extra revenue from selling one more unit. MR = change in TR ÷ change in Q.
Revenue under perfect competition
A perfectly competitive firm is a price taker. It can sell as much as it wants at the market price. So price stays the same for every unit, which means AR = MR = Price, and the curve is a horizontal line. TR rises in a straight line from the origin.
Revenue under imperfect competition
A firm with some market power faces a downward-sloping demand curve. To sell more, it must cut price. So AR falls as quantity rises, and MR falls faster than AR, because the lower price applies to all units, not just the extra one.
Here is an example:
| Quantity | Price = AR (₹) | TR (₹) | MR (₹) |
| 1 | 10 | 10 | 10 |
| 2 | 9 | 18 | 8 |
| 3 | 8 | 24 | 6 |
| 4 | 7 | 28 | 4 |
| 5 | 6 | 30 | 2 |
| 6 | 5 | 30 | 0 |
| 7 | 4 | 28 | -2 |
Observe: TR rises as long as MR is positive, reaches its maximum when MR is zero (at 5 to 6 units), and falls once MR turns negative.
A quick reminder of price elasticity of demand
Price elasticity of demand (Ed) measures how strongly the quantity demanded responds to a change in price. If Ed is greater than 1, demand is elastic (customers are sensitive); if less than 1, inelastic; if equal to 1, unitary elastic.
The relationship between MR, AR and elasticity
There is a neat formula:
MR = AR × (1 − 1/Ed), where Ed is the absolute value of elasticity.
This leads to three important results:
| Elasticity | MR | What happens to TR if price is cut? |
| Ed > 1 (elastic) | Positive | TR rises, because the quantity effect is stronger |
| Ed = 1 (unitary) | Zero | TR stays the same (it is at maximum) |
| Ed < 1 (inelastic) | Negative | TR falls, because the price effect is stronger |
Why does this matter to managers?
- A firm with market power will never operate on the inelastic part of its demand curve, because MR is negative there. It could raise price, sell less, earn more revenue and cost less.
- When demand is elastic, price cuts and discounts boost revenue. Fashion sales and airline fare promotions work this way.
- When demand is inelastic, small price rises increase revenue. Think of life-saving medicines, salt or cooking gas, where buyers do not cut consumption much.
Real example: a streaming service wonders whether to cut its monthly price from ₹200 to ₹150. If many new subscribers join (elastic demand), revenue rises. If hardly anyone new joins (inelastic demand), revenue drops. The service must estimate elasticity before choosing.
Read next (Part 5): Perfect Competition: Features, Price Determination and Equilibrium
