- Revenue is the total income a firm receives. Revenue = total sales X average price.
- To maximise revenue, the firm will set a price where the marginal revenue of last good sold is zero.
- We can explain with this diagram below.
Concepts
- Total Revenue (TR) = Price × Quantity
- Average Revenue (AR) = TR ÷ Q (same as demand curve)
- Marginal Revenue (MR) = Change in TR ÷ Change in Q
Revenue maximisation and elasticity
- When marginal revenue is positive, it means the firm is increasing its total revenue.
- If MR is negative, then total revenue is decreasing. Therefore, revenue is maximised when MR = 0.
Revenue and elasticity
- On a straight demand curve, the elasticity of demand varies. Initially, PED is elastic. This is because the % change in QD is greater than the % change in price.
- As price falls, revenue increases (MR>0) because demand is price elastic.
- However, later, the demand curve becomes inelastic. The % change in QD is less than the % change in price. Here, a fall in price leads to a decline in revenue, because demand is price inelastic.
- Where MR= 0, PED = 1 (unitary elasticity). At this point, changing price doesn’t change total revenue; the % change in price is the same as the % change in QD.
Why Firms Might Maximise Revenue
1. Separation of Ownership and Control
- Managers run firms on behalf of shareholders
- Managers may prefer:
- Larger firms and higher sales, which increase their prestige. It may also lead to manager benefits like higher salary and greater job security.
Greater market share. This could lead to higher profit in the long-run
Evaluation
- Firms still need to earn at least normal profit to stay in business.
- Revenue maximisation may just be a short-term factor
- Revenue maximisation is more likely in:
- Large firms
- Oligopolies
- Shareholders may intervene if profits are too low
Revenue Maximisation compared to other objectives
- Profit maximisation is where MR=MC
- Sales maximisation is max sales, but still making normal profit. (It is similar to revenue maximisation, but can be different.
- Revenue maximisation is at Q2 where MR = 0
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