Revenue

Revenue is the income a firm retains from selling its product after tax. Revenue is necessary for a firm in order to cover its costs of production. Just like costs, there a number of different types of revenue we should be aware of.



Total Revenue (TR): Price x Quantity

Total revenue (TR) is the total flow of income to a firm from selling a given quantity of output at a given price. Total revenue is found by multiplying price of the product by the quantity of the product sold.

Initially, as output increases total revenue (TR) also increases, but at a decreasing rate. It eventually reaches a maximum point and then decreases with further output.


Average Revenue (AR): Total Revenue / Quantity

Average revenue (AR), is the revenue per unit and can be found by dividing total revenue (TR) by the quantity sold (Q). AR is equivalent to the price of the product. The AR curve is also the firm's demand curve, as output increases the average revenue (AR) curve slopes downwards.


Marginal Revenue (MR)

Marginal revenue is the additional revenue gained from selling one extra unit of a good. The marginal revenue curve slopes downwards at twice the rate of the average revenue (AR) curve. This is because firms face a downward sloping demand curve, since the price must be cut to sell extra units, marginal revenue will always be below average revenue.

It is also important to note that when MR is 0, TR will be at it's peak. Beyond this point where MR is equal to 0, marginal revenue will become negative.

Role Of Profit in the Economy

1) Allocate resources

In the short-run firms make super-normal profit. This attracts new firms to the market until super-normal is competed away. Profits therefore allocate resources by putting resources into places where super-normal profit is made.


2) Reward Entrepreneurs

Entrepreneurs bring together the factors of production and take risks. The role of the entrepreneur is to innovate and create dynamic efficiency. This would not be possible without the incentive of profit.


3) Source of finance for investment / incentive to invest

Although investment is often financed through borrowing, a source of finance is profit retained by firms. Investment in turn will result in higher profits as costs are reduced due to higher productivity.

There is an even greater incentive to retain profit for investment as the government award tax relief to firms who stimulate economic growth.


4) Incentive to reduce inefficiency

Inefficiency (e.g. X-inefficiency) increases production costs for firms therefore lowering profit. By lowering inefficiency firms can achieve higher profits.

Types of Profit

1. Accounting Profit

Total revenue minus only the firms explicit costs.

• Explicit costs are monetary costs a firm incurs
• Implicit costs are the opportunity cost of a firm’s resources - alternative jobs that resources, such as labour, could be used for.

2. Economic Profit

The measure of a firms’s economic profit used by economists. Total revenue - total costs (including both explicit and implicit costs).

Example

Imagine a farmer, her payments for land and equipment rental and other supplies come to £10,000 a year (explicit cost). The only input she supplies is her own labour. Revenue from strawberry production is £22,000 per year.

The only other employment opportunity is running a B&B at a salary of £11,000 per year (implicit cost).

• Accounting Profit: Total revenue (£22,000) - Explicit costs (£10,000) = £12,000


• Economic Profit: Total revenue (£22,000) - (Explicit costs £10,000 - implicit costs £11,000) = £1000