Average revenue is revenue per product. For example, if your firm’s total revenue is $200, and you are selling 100 products, then your average revenue is $200 divided by 100, or $2.
Marginal revenue is the additional revenue from selling one more product. Let’s say that your firm’s total revenue is $200 when you sell 100 products, and your total revenue is $220 when you sell 110 products. Then your marginal revenue is $20 (the additional revenue) divided by 10 (the additional production), or $2.
We use the following abbreviations:
|Average Revenue = AR
Marginal Revenue = MR
Total, Average, and Marginal Revenue Curves
In Unit 2, we learned that if the supply of a product increases, its equilibrium price decreases. However, one firm in pure competition makes up a very small part of the entire industry. Therefore, if this one firm’s quantity sold increases, it will have an insignificant effect on the price. In the above example, the purely competitive firm increases its quantity sold from 100 to 110. If the other firms in the industry do not increase their quantity supplied, then the market supply does not increase significantly, and we can assume that the price remains constant at $2. Note that if the price is constant, then the average revenue and marginal revenues equal the price.
Below is a table of a hypothetical firm, which has a choice of selling quantities ranging from 0 to 130. The product’s price is constant at $2. Therefore, average and marginal revenue are $2, as well. For example, at a quantity of 110 units, the total revenue is 110 times $2, or $220. The marginal revenue is the change in total revenue divided by the change in quantity. At a quantity of 110, the change in total revenue is $20 (relative to the previous quantity of 100), and the change in the quantity is 10 (110 minus 100), so the marginal revenue is $20 divided by 10, or $2. The average revenue is the total revenue divided by the quantity produced. For example, at a quantity of 120, the total revenue is $240. Therefore, the average revenue at this quantity is $240 divided by 120, or $2.
Plotting the points for the quantities and total revenue from the table above, we can draw the following total revenue curve:
Plotting the points for the quantities and marginal and average revenue from the table above, we can draw the following marginal and average revenue curve. Because the price is constant, the marginal and average revenue curves are the same. The demand curve (D) of a purely competitive firm is also the same as the MR and AR curves.
In the next section, we will combine the firm’s marginal and average revenue curves with its cost curves, and arrive at the profit maximizing output and total profit value.