The Average Revenue, Marginal Revenue and Price Elasticity of Demand
In economics, the total revenue test is a means for determining whether demand is elastic or inelastic. If an increase in price causes an increase in total revenue, then demand can be said to be inelastic The mathematical link between them comes from the formula of the price elasticity of demand: E d = − ((Q 2 − Q 1) / ( P. The inverse relationship between price and quantity demanded is the critical element in Remember that marginal revenue is the change in total revenue that occurs when Marginal revenue is related to the price elasticity of demand — the. Sep 3, Relationship between price elasticiy(e) and Average Revenue(AR), Marginal Is the relationship between elasticity of demand and total revenue always true?.
This distance is equal to the slope of the total revenue curve at that quantity. The marginal revenue curve thus crosses the horizontal axis at the quantity at which the total revenue is maximum. Past the mid-point of a straight line demand curve, the marginal revenue becomes negative. Why is marginal revenue important?
Elasticity, Total Revenue and Marginal Revenue
This question is best answered by way of example. Consider the market for fresh eggs in a locality. Suppose that the government permits producers to establish an Egg Marketing Board with the power to set the price of eggs to the consumer and allocate output quantities to all individual producers.
Purchases of eggs from outside the local area are prohibited. This situation is shown in Figure 6. A horizontal supply curve is a reasonable assumption here because most of the inputs used to produce eggs can be purchased by egg producers at fixed market pricesthese inputs are used by other industries and producers of eggs use a small fraction of the available supply. This implies that chicks can be hatched and raised to hens at constant cost.
Egg producers like this arrangement because it enables them to sell their eggs to consumers at a price above the cost of production, yielding a profit indicated by the shaded area in Figure 6. The problem faced by the Marketing Board, acting on their behalf, is to determine the quantity level that will maximize that profit.
At a lower output quota there is a gain from a higher price, but the quantity producers sell will be less. At every quota level the Board's problem is to decide whether to increase the output quota by one unit. It will do this if the additional revenue from selling another unit to consumersthe marginal revenue is greater than the additional to total cost from producing another unitcalled the marginal cost.
The marginal revenue is given by the thick line in Figure 6. And the width is the quantity. So that total revenue is the area right over there.
Now, let's go to point-- let me do a couple of them just to really make it clear for us. Let's try to point B. So at point B when our price is 8 and our quantity is 4, 4 per hour. And once again, you can see that visually.
The height here is 8. And the width here-- so the height of this rectangle is 8. And the width is 4. The total revenue is going to be the area. It's going to be the height times the width just like that. Now, let's go to a point that I haven't actually graphed here. Actually, let me just-- actually, I'll go through all the points just for fun.
So now at point C, we have 5. The quantity is 9. And you have another 4.
So that is So once again, it's going to be the area of this rectangle. Area of that rectangle right over there. So you might already be noticing something interesting.
As we lower the price, at least in this part of our demand curve, as we lower the price, we are actually increasing not just the quantity were increasing the total revenue.
Let's see if this keeps happening. So if we go to point D, I'll do it in that same color. And we are selling 11 units. So 11 times 4. Let's see, this is going to be 44 plus 5.
Once again, that is So that this rectangle is going to have the same area as that pink one that we just did for scenario C. And I'll actually just do one more down here, just to see what happens. Because this is interesting. Now we lower the price. And it looks like things didn't change much. And now, let's go-- let's just do one more point actually for the sake of time. And I encourage you to try other ones. Try F on your own. My quantity is 16 burgers per hour.
I sell a total of 32 burgers. Now actually, let's just do the last one, F, just to feel a sense of completion.Relation between TR and MR , Relation between AR and MR in hindi, Concept of revenue Part -2
I sell 18 burgers per hour. And once again, that's the area of this rectangle, this short and fat rectangle right over here. And E was the area-- the total revenue in E was the area of that right over there. And you could graph these just to get a sense of how total revenue actually changes with respect to price or quantity.
Lets plot the total revenue with respect to quantity. So let's try it out. So if you-- let me plot it out. Factors That Affect Elasticity The factors that affect the price elasticity of any product include: As in the case of rising prices for oatmeal, consumers can shift their purchases to similar products if they are readily available. Coca-Cola and Pepsi are products that can be easily substituted for each other when prices change.
This is an example of elastic demand. If the alternatives are limited, the demand is less elastic. Necessities are products that people must have regardless of the price. Everyone has to drink water, so if the water company raises prices, people continue to consume and pay for it.
Total revenue test
Luxuries are optional; they aren't necessary to live. Large-screen HDTVs are nice to have, but if the prices go up, consumers can put off buying them. Share of the consumer's income: Products that consume a high proportion of a family's income are sensitive to price increases. A car is a good example. Increases in car prices can cause a family to delay purchasing a new car. They keep their old car longer and make the necessary repairs.