1. What are total, average, and marginal revenue?

Firms get income, or revenue, by selling their product to buyers. To make good decisions, firms must know how their revenue changes when they produce and sell different quantities of output. Total revenue, average revenue, and marginal revenue are all terms that represent how much revenue a firm gets at different quantities of output sold.

Total revenue is the amount of revenue a firm receives at different quantities. It is calculated by the equation TR = P ´ Q, where P represents the price of the product, and Q is the quantity sold.

Average revenue is revenue per unit of output. It is calculated by the equation AR = TR/Q. Average revenue is the same as demand.

Marginal revenue is the additional revenue gained by selling one more unit of the product. It is calculated by the equation MR = change in TR/change in Q.

2. Do consumers respond to price changes?

When your favorite clothing store has a sale on jeans, do you go out and buy some? When the bookstore raises the price of required textbooks, do you buy fewer textbooks? We know from our study of demand that people usually respond to price changes by changing the quantity they buy. Most people respond more to changes in the price of jeans than to changes in the price of required textbooks.

Elasticity gives us a way to measure how much people respond to price changes. The price elasticity of demand is the percentage change in quantity demanded of a good divided by the percentage change in price of that good. Although the quantity demanded changes in the opposite direction from the change in price, we usually talk about the price elasticity of demand as a positive number.

The possible values of the price elasticity of demand are divided into ranges:

We say that demand is elastic if the price elasticity of demand is more than one.

We say that demand is inelastic if the price elasticity of demand is less than one.

We say that demand is unit elastic if the price elasticity of demand is equal to one.

3. What is the relationship between revenue and the price elasticity of demand?

When your favorite store has a sale on jeans, it sells more jeans but takes in less revenue per pair. Did total revenue increase or decrease because of the sale?

That depends on the price elasticity of demand. If the demand for jeans is elastic, the percentage change in quantity is bigger than the percentage change in price, so reducing the price of jeans increases total revenue.

But if the demand for jeans is inelastic, the percentage change in quantity is smaller than the percentage change in price, so reducing the price of jeans decreases total revenue. When demand is inelastic, raising the price increases total revenue.