Reviewed by Omotolani Ajileye
Edited by Nna Rejoice
Table of Contents
Meaning of Revenue and Profit
Revenue is the total income a firm earns from the sale of goods or services over a given period. It is calculated by multiplying the price of the product by the quantity sold.
For example, if a business sells 20 units of a product at ₦2,000 each, its revenue will be ₦40,000. Revenue focuses only on the money coming into the business from sales, without considering any expenses incurred during production or distribution.
Profit, on the other hand, is the financial gain a firm makes after subtracting all costs of production from its total revenue. These costs may include expenses such as payments for raw materials, wages, transport, and rent.
Profit is calculated by deducting total cost from total revenue. For instance, if a firm earns ₦40,000 in revenue and spends ₦25,000 on production, the profit will be ₦15,000. While revenue shows how much a business earns, profit indicates how well the business is performing financially.
Types of Revenue
a. Total Revenue (TR):
Total Revenue is the total amount of money a firm earns from the sale of its goods or services over a given period. It is calculated by multiplying the price of the product by the quantity sold (TR = Price × Quantity).
This means that as a firm sells more units, its total revenue will increase, provided the price remains constant. For example, if a firm sells 20 units of a product at ₦500 each, its total revenue will be ₦10,000.
Total revenue is important because it shows the firm’s overall earning power from its core business activities. When represented graphically under simple conditions where price does not change, the total revenue curve is an upwards-sloping straight line starting from the origin.
b. Average Revenue (AR):
Average Revenue refers to the amount of revenue a firm earns per unit of output sold. It is obtained by dividing total revenue by the total quantity of goods sold (i.e. AR = Total Revenue ÷ Quantity or AR = Price).
In most cases, especially under perfect competition, average revenue is equal to the price of the product, since all units are sold at the same price. For instance, if a firm’s total revenue is ₦1,000 from selling 10 units, the average revenue is ₦100 per unit.
Average revenue is significant because it helps firms understand how much income each unit contributes to overall earnings. It is also closely related to the demand curve, as it shows the price consumers are willing to pay at different levels of output.
c. Marginal Revenue (MR):
Marginal Revenue is the additional revenue a firm earns from selling one more unit of its product. It is calculated as the change in total revenue resulting from a change in the quantity sold, usually one extra unit (MR = Change in Total Revenue ÷ Change in Quantity).
For example, if total revenue increases from ₦2,000 to ₦2,300 when output rises from 10 to 11 units, the marginal revenue of the 11th unit is ₦300. Marginal revenue is important in decision-making because it helps firms determine whether increasing production will lead to higher profits.
If marginal revenue is positive, selling more units adds to total revenue, but if it starts to decline, it may indicate that the firm must lower prices to sell additional units, especially in imperfect market conditions.
Example Table:
Relationship Between Average Revenue and Marginal Revenue
The relationship between Average Revenue, AR, and Marginal Revenue, MR, varies depending on the market structure in which a firm operates. In general, AR represents the revenue earned per unit of output, while MR is the additional revenue gained from selling one more unit.
The key to understanding their relationship lies in how price behaves as output changes. If price remains constant, AR and MR will behave the same way. However, if price must be reduced to sell more units, the two will differ, with MR typically changing faster than AR.
In perfect competition, AR and MR are equal and constant at all levels of output. This is because firms are price takers, meaning they have no control over the market price and must accept the price determined by the industry.
Every additional unit sold adds the same amount to total revenue, since the price does not change. As a result, AR, which is equal to price, remains constant, and MR, which is the addition to total revenue from each extra unit sold, is also constant and equal to AR. Graphically, both AR and MR appear as a horizontal line.
In imperfect competition, such as monopoly or monopolistic competition, AR and MR are both downwards sloping, but MR lies below AR. This is because the firm must reduce the price to sell additional units. When the price is reduced, it applies not only to the extra unit sold but also to all previous units.
Therefore, the additional revenue gained from selling one more unit, MR, is less than the price of that unit, AR. This explains why MR falls faster and lies below the AR curve, reflecting the loss in revenue from lowering the price on existing units.
Summary
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Revenue is income from sales; profit is what remains after costs
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Total Revenue is total earnings
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Average Revenue is revenue per unit, usually equal to price
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Marginal Revenue is extra revenue from selling one more unit
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In perfect competition, AR = MR
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In imperfect competition, MR is less than AR
Revenue is income from sales; profit is what remains after costs
Total Revenue is total earnings
Average Revenue is revenue per unit, usually equal to price
Marginal Revenue is extra revenue from selling one more unit
In perfect competition, AR = MR
In imperfect competition, MR is less than AR
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