AQA A-Level Economics · Revision notes
4.1.4.6 Marginal, Average and Total Revenue
Revenue is the income a firm receives from selling its output. Economists use three measures of revenue, and the relationship between them — and with price elasticity of demand — underpins every diagram of firm behaviour that follows.
Total, average and marginal revenue
Total revenue (TR) is the total income from sales.
TR = price × quantity sold
Average revenue (AR) is revenue per unit sold.
AR = TR / quantity
Key idea: Since TR is price multiplied by quantity, AR is simply the price. This is why a firm's AR curve is also its demand curve.
Marginal revenue (MR) is the change in total revenue from selling one more unit.
MR = change in TR / change in quantity
A worked example
A firm faces a downward-sloping demand curve, so it must lower its price to sell more.
| Price (£) | Quantity | TR (£) | AR (£) | MR (£) |
|---|---|---|---|---|
| 10 | 1 | 10 | 10 | — |
| 9 | 2 | 18 | 9 | 8 |
| 8 | 3 | 24 | 8 | 6 |
| 7 | 4 | 28 | 7 | 4 |
| 6 | 5 | 30 | 6 | 2 |
| 5 | 6 | 30 | 5 | 0 |
| 4 | 7 | 28 | 4 | −2 |
Three patterns stand out:
- AR equals price at every output.
- MR is below AR. To sell one more unit, the firm cuts the price on every unit sold, not just the last one. Selling the 3rd unit at £8 adds £8, but the first two units now sell for £1 less each, so MR is £8 − £2 = £6.
- TR is maximised where MR = 0, between 5 and 6 units here. Beyond that, MR is negative and TR falls.
The shape of the revenue curves
The shape of the revenue curves depends on whether the firm is a price maker or a price taker.
- A price maker faces a downward-sloping demand curve. It can set its own price, but to sell more it must lower that price. Any firm with some market power is a price maker, from a monopoly to a small firm in monopolistic competition.
- A price taker is one of many firms selling an identical product, so it has to accept the price set by the market. It can sell as much as it likes at that price, but nothing at a higher one. This is the case in perfect competition.
| Price maker | Price taker | |
|---|---|---|
| Typical market structure | Monopoly, oligopoly, monopolistic competition | Perfect competition |
| What happens to price as it sells more | Price must fall | Price stays at the market price |
| AR (demand) curve | Slopes downwards | Horizontal at the market price |
| MR curve | Below AR. For a straight-line AR, MR starts at the same point on the price axis, falls twice as steeply and cuts the quantity axis halfway to where AR does | The same line as AR, so AR = MR = price |
| TR curve | Rises, peaks where MR = 0, then falls, giving an inverted U shape | A straight line rising from the origin |
The worked example above is a price maker. If the same firm were a price taker with a market price of £10, every extra unit would add exactly £10, so MR would be £10 at every output and TR would rise by £10 for each unit sold.
Price elasticity of demand and revenue
Price elasticity of demand (PED) tells a firm what will happen to total revenue when it changes its price.
- Elastic demand (PED greater than 1 in absolute terms): a price cut raises TR, because quantity rises proportionately more than price falls. MR is positive.
- Unitary elasticity (PED = 1): a price change leaves TR unchanged. MR = 0 and TR is at its maximum.
- Inelastic demand (PED less than 1): a price cut reduces TR, because quantity rises proportionately less than price falls. MR is negative.
Along a straight-line demand curve, PED falls as price falls: demand is elastic above the midpoint, unitary at the midpoint and inelastic below it. The midpoint of the AR curve is directly above the point where MR = 0.
A calculation using PED A firm sells 1,000 units at £20, so TR is £20,000. PED is −2. If it cuts its price by 10% to £18, quantity rises by 20% to 1,200. New TR is £18 × 1,200 = £21,600, a rise of £1,600. Because demand is elastic, the price cut raises revenue.
Key idea: A profit-maximising firm never chooses a price on the inelastic part of its demand curve. If demand is inelastic, raising the price would increase revenue and, by selling less, reduce costs, so profit would rise.
Key terms
| Term | Meaning |
|---|---|
| Total revenue | Price multiplied by quantity sold |
| Average revenue | Revenue per unit sold, equal to price |
| Marginal revenue | The change in total revenue from selling one more unit |
| Price maker | A firm with some market power that faces a downward-sloping demand curve, so it must lower its price to sell more |
| Price taker | A firm that must accept the market price and can sell any quantity at that price |
| Unitary elasticity | PED equal to 1, where total revenue is at its maximum |
Common mistakes
- Treating AR and MR as the same for every firm. They are equal only for a price taker.
- Calculating MR as the price of the extra unit. MR also reflects the lower price on all the other units sold.
- Drawing MR with the same slope as AR. For a straight-line AR, MR falls twice as steeply.
- Linking a price cut to higher revenue regardless of PED. It only raises revenue when demand is elastic.
- Placing maximum TR where MR is highest. TR peaks where MR equals zero.
How this has been examined
In the AQA papers indexed on this site, this topic has appeared in one format:
- 1-mark multiple choice — asked 5 times across 4 series (2020 to 2024)
Where this goes next
PED itself is covered in 4.1.3.2 Price, income and cross elasticities of demand. Revenue is combined with cost in 4.1.4.4 Costs of production and 4.1.4.7 Profit, and the revenue conditions for profit maximisation and other objectives are in 4.1.5.2 The objectives of firms. The horizontal AR = MR of a price taker is central to 4.1.5.3 Perfect competition.
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