Revenue is money earned by a firm for selling its output.
Total Revenue Total revenue (TR) is the total money earned by a firm for selling its output.
As price falls and output rises, TR rises, reaches a maximum point and then falls.
TR is zero at the origin because . TR rises because as price falls, quantity rises more in proportion. TR is maximized at TR*. TR falls because as price falls, output rises less in proportion.
Average Revenue Average revenue (AR) is a firm’s revenue per unit of output.
so AR is the firm’s demand curve. AR shows the average price charged for each quantity of output.
As price falls and output rises, AR falls.
AR slopes downwards because prices must fall to induce an increase in quantity demanded.
Total Revenue, Average Revenue and Marginal Revenue As price falls and output rises, MR is positive so TR rises. At P* and Q*, MR is zero so TR is maximized. Then as price falls further and output rises, MR is negative so TR falls.Total Revenue, Average Revenue and Marginal Revenue
Perfectly Elastic Average Revenue and Marginal Revenue A perfectly elastic demand curve results in a horizontal AR and MR curve. A constant price is charged so . At price P* an infinite amount of output is demanded.
Perfectly Elastic Average Revenue and Marginal Revenue
Straight Total Revenue A perfectly elastic MR curve and AR curve results in a straight TR curve. At a constant price, MR is constant so TR rises by a constant amount for each extra output sold.
Cost is the cost to a firm for using the factors of production.
Fixed Costs Fixed costs (FC) are costs that do not vary with output. They stay the same no matter what level of output is produced. FC includes rent, salaries, interest payments, insurance and advertising.
Total fixed costs (TFC) equals all FC added together.
Average fixed costs (AFC) are total fixed costs divided by output.
Variable Costs Variable costs (VC) are costs that vary directly with output. VC includes raw materials, components, wages, electricity bills and transport costs.
Total variable cost (TVC) equals all VC added together.
Average variable costs (AVC) are total variable costs divided by output.
AVC are zero when output is zero. As output begins to rise, AVC begins to fall because of rising productivity (specialization), reach a minimum point and then begins to rise due to diminishing returns.
Diminishing Returns: An Explanation Basically, the Law of Diminishing Returns states that: Adding a variable factor of production (labour) to a fixed factor of production (machinery) will initially cause output to rise at an increasing rate (more productive) and then a decreasing rate (less productive).
All the cost curves (AC, AVC, FC, TC) are drawn for the short-run only, when at least one factor of production is fixed. Assume a firm with fixed factors of production, specifically a building and a big piece of machinery. The firm’s variable factor is labour and the firm hires more workers to produce more output.
Labour Specialization At first the firm can add workers, let workers specialize, become more efficient, increase output and reduce AVC.
At some point though, the firm begins to hire too many workers. Too many workers leads to over-crowding. This causes workers to become inefficient as they start talking rather than working, get in each other’s way and make each other wait to use machinery. So output still rises but not by much because workers become inefficient so AVC rises.
As output rises, AC falls, reaches a minimum point and then rises.
AC are high at first due to FC, AC falls rapidly due to increasing productivity (specialization) and then AC begins to rise because of diminishing returns.
