Average Revenue: Revenue per Unit Sold
1. What is Average Revenue? The Simple Formula
Imagine you run a lemonade stand. If you sell 10 cups of lemonade and earn a total of $20.00, how much does each cup contribute to your revenue? This is your Average Revenue. The basic formula is simple:
For the lemonade stand, the calculation would be: $AR = \frac{\$20.00}{10} = \$2.00$. This means the average revenue, or revenue per cup, is $2.00. Notice that this is also the price you charged for each cup. In most cases, Average Revenue equals the price of the product.
2. Average Revenue and Market Structures
The way Average Revenue behaves depends on the type of market a company is in. Let's look at two common examples using a table.
| Market Type | Key Feature | Effect on Average Revenue |
|---|---|---|
| Perfect Competition (e.g., a wheat farmer) | Many sellers, identical products. | AR is constant. The farmer sells every bushel at the market price. AR = Price. |
| Monopoly (e.g., a local water utility) | One seller, unique product. | AR decreases as more is sold. To sell more water, the company must lower the price for all units, so AR falls. |
3. Practical Example: The School Bake Sale
Your class is having a bake sale to raise money. You are in charge of pricing brownies.
- Scenario A (Price Taker): Every other stand is selling brownies for $1.00. If you try to sell for $1.50, no one will buy. If you sell for $0.50, you will sell out quickly but make less money per brownie. Your Average Revenue is fixed at $1.00 no matter how many you sell. If you sell 50 brownies, $AR = \frac{\$50}{50} = \$1.00$.
- Scenario B (Price Maker): Your brownies are famous—they're gooey, huge, and the only ones at the sale. You can set the price. You notice you can sell 10 brownies at $3.00 each (TR = $30.00, AR = $3.00), but to sell 20, you must lower the price to $2.50 each (TR = $50.00, AR = $2.50). Your Average Revenue goes down as you sell more because you have to lower the price to attract more customers.
4. Important Questions About Average Revenue
❓ Q1: Is Average Revenue the same as profit?
✅ A: No. Average Revenue is the money coming in per unit. Profit is what's left after you subtract all costs. For example, if you sell a bracelet for $10.00 (AR = $10.00), but it cost you $7.00 in materials, your profit per unit is only $3.00.
❓ Q2: Why is the Average Revenue curve also the demand curve?
✅ A: The demand curve tells us the maximum price consumers are willing to pay for each specific quantity. Since Average Revenue is simply that price, the two curves are identical when plotted on a graph. Each point on the demand curve shows both the price and the average revenue for that quantity sold.
❓ Q3: Can Average Revenue ever be zero or negative?
✅ A: Average Revenue can be zero if a company gives away products for free, but it is almost never negative. A negative AR would mean a company is paying customers to take the product, which doesn't happen in normal business situations. Total Revenue is always zero or positive, so AR is also zero or positive.
Footnote
- Total Revenue (TR): The total amount of money a firm receives from selling its goods or services. Calculated as Price × Quantity.
- Marginal Revenue (MR): The additional revenue gained from selling one more unit. It is closely related to Average Revenue.
- Price Taker: A firm in a perfectly competitive market that must accept the prevailing market price and cannot influence it.
- Price Maker: A firm (like a monopoly) that has the power to set its own price because it faces little to no competition.