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Revenue

Revenue

BIBLIOGRAPHY

A firms revenue is distinguished from its profit: Revenue is the total money received by the firm (total revenue), whereas profit is total revenue less total cost. Revenue and total revenue are usually synonyms, but the latter term is used especially to delineate total money received, as distinct from the marginal revenue of each unit and the average revenue received for all units.

Marginal revenue is a central concept in microeconomic theory (Marshall [1890] 1961). It is the change in total revenue created by a one-unit increase in the quantity sold. As long as marginal revenue is positive, increasing output will cause total revenues to increase. Mathematically, marginal revenue is the derivative of total revenue with respect to quantity. Average revenue is the money collected per unit, or total revenue divided by quantity. When all units of a firms output (q ) are sold for the same price (p ), total revenue is price multiplied by quantity, pq, and both marginal and average revenue are equal to price.

A perfectly competitive firms marginal revenue is determined solely by price because a single firms chosen quantity of production has a negligible effect on the market price. When one firm in a perfectly competitive market decides to produce and sell one more unit of output, the market price does not change, and so the increase in the firms revenues is exactly equal to the number of dollars brought in by that extra unit: its price. The mathematics behind this intuition recognizes that in this case, the derivative of total revenue is d (pq )/dq = p because price (p ) does not change as the firms output (q ) changes.

A firm with market power wields a double-edged sword. The firm can set the price for its output, but it still must contend with a downward-sloping demand curve: Selling more output requires a decrease in price, by the law of demand. Because of these two effects (increasing quantity while decreasing price), marginal revenue is made up of two components. When the firm decides to produce and sell one more unit of output, (1) selling more of the good increases revenue, while (2) lowering price means that less revenue is collected on each of the units that could have been sold at the higher price. Thus marginal revenue must be less than price for a firm with market power (rather than equal to price, as in the case of perfect competition, above). The two components of revenue are, respectively, the output effect and the price effect. A mathematical analysis recognizes that price now changes as the firms quantity changes: The derivative dp /dq is nonzero. The derivative of total revenue is thus d (pq )/dq = p + (dp /dq )q. The first term is the output effect and the second term is the price effect. The price effect is negative because price falls when quantity rises, and this means that the marginal revenue of producing and selling one more unit of output is less than the price for which each unit can now be sold.

Marginal revenue is also closely related to the own-price elasticity of demand, or the responsiveness of quantity demanded to a change in price. A decrease in price when demand is elastic causes a greater percentage increase in quantity demanded than the percentage decrease in pricethus revenues must increase. A decrease in price when demand is inelastic, in contrast, causes a smaller reaction in quantity demanded, and so revenues will fall. This is especially relevant when a firm is choosing the optimal quantity to sell and costs are fixed as the quantity sold changes: Maximizing total revenue is equivalent to maximizing profits in this case. For example, a toll-road operator should decrease price as long as the resulting increase in drivers (quantity) compensates for the loss in revenue per unit. In other words, price should be decreased as long as demand is still elastic. Total revenue (and in this case, profits) will be maximized when demand is neither elastic nor inelastic. This is also the quantity at which marginal revenue is zero.

The firm with market power thus far has been assumed to sell all units of its output for the same price; that is, it does not price discriminate. When the firm does price discriminate it can do so either by setting separate prices for each customer or setting separate prices for different customer groups, or by adjusting price according to each customers quantity purchased. Average revenue will vary as quantity changes, depending on the method of price discrimination, and so total revenue may not be simply price multiplied by total quantity. One example is a quantity discount: In this case, larger quantities will have lower average revenue than smaller quantities. Another example is when the customer must pay a fee for the right to purchase each unit (a cover charge or membership fee): Total revenue includes both this fee and the revenues collected on each units sale, so average revenue (per unit sold) decreases as quantity increases.

In fact, the ability to price discriminate allows the firm with market power to reduce the negative effect that the law of demand has on marginal revenue. The firm can set a higher price for those units of output for which customers have a higher willingness to pay, and set a lower price only for those units of output for which there is a lower willingness to pay. As output increases, charging separate prices for each unit or group of units purchased mitigates the price effect. The price effect may even fall to zero. Thus, when the firm price discriminates, it can be true that marginal revenue approaches price and the economic outcome may approach that of perfect competition, except that the economic value created is reallocated toward the price discriminating firm and away from the customer. This means that a firm with market power may produce more output if it can price discriminate than if it cannot. The firm will benefit from this practice, and this advantage to society may more than outweigh the loss to the consumer.

SEE ALSO Revenue, Average; Revenue, Marginal

BIBLIOGRAPHY

Marshall, Alfred. [1890] 1961. Principles of Economics. 8th ed. New York: Macmillan.

Christopher S. Ruebeck

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Revenue

REVENUE


Revenue is a term commonly used in business. A company's revenue is all of the money it takes in as a result of its operations. Another way of defining a company's revenue is as a monetary measure of outputs, or goods sold and services rendered, with expense being a monetary measure of inputs or resources used in the production of goods or services. On the other hand, a company's net income or profit is determined by subtracting its expenses from its revenues. Thus, revenues are the opposite of expenses, and income equals revenues minus expenses.

For accounting purposes, income is distinguished from revenues. Income is an important concept in economics as well as accounting. Accountants prepare an income statement to measure a company's income for a given accounting period. Economists are concerned with measuring and defining such concepts as national income, personal income, disposable personal income, and money income versus real income. In each field the concept of income is defined in slightly different terms.

An example of revenue is when a store sells $300 worth of merchandise, for which it originally paid $200. In this example the company's revenue is $300, its expense is $200, and its net income or profit is $100. Other expenses that are typically deducted from sales or revenues include salaries, rent, utilities, depreciation, and interest expense.

See also: Income

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revenue

rev·e·nue / ˈrevəˌn(y)oō/ • n. income, esp. when of a company or organization and of a substantial nature. ∎  a state's annual income from which public expenses are met. ∎  (revenues) items or amounts constituting such income: the government's tax revenues. ∎  the government department collecting such income.

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"revenue." The Oxford Pocket Dictionary of Current English. . Encyclopedia.com. 18 Oct. 2017 <http://www.encyclopedia.com>.

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Revenue

REVENUE

Return or profit such as the annual or periodic rents, profits, interest, or income from any type of real orpersonal property, received by an individual, a corporation, or a government.

Public revenues are the sources of income that a government collects and receives into its treasury and appropriates for the payment of its expenses.

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"Revenue." West's Encyclopedia of American Law. . Encyclopedia.com. 18 Oct. 2017 <http://www.encyclopedia.com>.

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revenue

revenue †yield or profit of property; income from possessions XV; (annual) income gen.; department of the civil service dealing with national funds XVII. — (O)F. revenu, †revenue, m. and fem. pp. of revenir :- L. revenīre return, f. RE- + venīre COME.

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revenue

revenue: see finance.

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