Relationship between Revenues (AR, MR and TR)

What is Revenue?

Revenue is the amount received by an organisation from the sale of a given quantity of a commodity in the market. There are three important terms in Revenue; viz., Total Revenue, Average Revenue, and Marginal Revenue. The total receipts from the sale of a given quantity of a commodity are known as Total Revenue. The revenue per unit of the output sold of a commodity is known as Average Revenue. The additional revenue generated by selling an additional unit of output is known as Marginal Revenue. The relationship between revenues can be studied in two situations:

• When the Price remains constant
• When the Price falls with a rise in Output

Relationship between AR and MR (When Price Remains Constant)

In markets like perfect competition, the price of a commodity remains constant at all levels of output and any firm in the industry can not influence the market price. The sale of the product can be higher or lower at the same price only. This implies that the sale of any additional unit (MR) will be the same as AR. As a result, both AR and MR curves coincide in a horizontal straight line parallel to the X-axis.

Relationship between AR and MR

As seen in the given schedule and diagram, price (AR) remains the same at all levels of output and is equal to MR. Therefore, the demand curve (or AR curve) is perfectly elastic.

Relationship between TR and MR (When Price remains Constant)

In markets like perfect competition, the price of a commodity remains constant at all levels of output and any firm in the industry can not influence it. The sale of a product can be higher or lower at the same price only. Since MR remains constant and MR = AR, TR also increases at a constant rate. Hence, the TR curve is a straight line with a positive slope. As TR is zero at the zero level of output and increases at a constant rate with the increase in sales, the TR curve starts from the origin.

Relationship between TR and Price Line

When price remains same at all output levels, then Price = AR = MR. It means that the price line is same as the MR curve. We also know that, TR = ∑MR; therefore, the area under the price line or MR curve will be equal to TR. 

Relationship between TR and MR

In the above graph, TR at OQ output level is equal to OP x OQ which is equal to Area under price line.

Relationship between AR and MR (When Price falls with a rise in Output)

In markets like imperfect markets, the price tends to fluctuate and adjust according to the market forces of demand and supply. A firm can increase its volume of sales only by decreasing the price, so the AR falls with an increase in sales. The revenue from every additional unit; i.e., MR will be less than AR. As a result, both AR and MR curves slope downwards from left to right.

Relationship between AR and MR

Both AR and MR fall with an increase in output. However, MR falls at a rate more than the rate of fall in AR, making the MR curve steeper than the AR curve. MR curve can be zero and negative, while AR remains positive.

It must be noted that MR can fall to zero and can even become negative. However, AR can be neither be zero nor negative as TR is always positive.

Relationship between TR and MR (When Price falls with a rise in Output)

In markets like imperfect markets, the price tends to fluctuate and adjust according to the market forces of demand and supply. A firm can increase its volume of sales only by decreasing the price, so the AR falls with an increase in sales. MR is the addition to TR when one more unit of output is sold. So, TR will increase when MR is positive, TR will fall when MR is negative, and TR will be maximum when MR is zero.

Relationship between TR and MR

In the above graph, the TR curve increases as long as MR is positive, reaches its highest point (A) when MR is zero (B) and starts to decline when MR becomes negative. Thus, the relationship between TR and MR when price falls with an increase in output can be summed up as:

• TR increases as long as MR is positive.
• TR is at its maximum when MR is zero.
• TR starts to decline when MR is negative.

General Relationship between AR and MR

The relationship between AR and MR depends on whether the price remains the same or falls with a rise in output. However, if nothing is mentioned about the nature of price with the rise in output, then the following general reflection exists between AR and MR:

1. AR increases when MR is higher than AR (When MR > AR, AR increases).

2. AR is maximum and constant when MR is equal to AR (When MR = AR, AR is maximum).

3. AR falls when MR is less than AR (When MR < AR, AR falls).

General Relationship between AR and MR