The Relationship Between Marginal Revenue & Average Revenue
Marginal revenue and average revenue constitute concepts originating from the world of microeconomics. As the branch of economics concerned with small individual units, microeconomics concerns itself with individuals, families, single businesses and other micro, or small, entities. Marginal revenue and average revenue constitute similar, and sometimes even identical, ideas. The primary relationship between these two stems from their connection to the overall notion of revenue in the field of microeconomics.
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Marginal Revenue
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Marginal revenue constitutes the difference made to revenue by the sale of a unit. For instance, assume you own a store that sells yams, and a yam cost $5. If you sell 10 yams in one day, your revenue equals $50. If you sell one additional yam just before closing, your revenue changes from $50 to $55. This $5 change qualifies as marginal revenue, as does every $5 accrued through the sale of a yam.
Average Revenue
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Average revenue constitutes the average price of a unit. You can calculate average revenue by dividing total revenue by quantity. In standard business and economic parlance, average revenue is known as price per unit. For instance, if you generate $1,500 in a week from the sale of 200 yams, the average revenue equals your total revenue of $1,500 divided by your number of units sold, or 200. Thus average revenue equals $7.50, the average price of each yam sold during that week.
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Similarities
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On the surface of things, average revenue and marginal revenue appear identical. Both stem from the overall concept of revenue and relate directly to the price of items. In a perfect world, in which demand exerts no influence on the price of a commodity, marginal revenue and average revenue exhibit no difference when represented mathematically. If you can maintain demand of an item without changing the price, average revenue and marginal revenue are the same, represented graphically by a single straight, horizontal line.
Differences
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Other than the obvious difference of perspective — marginal revenue looks at revenue, while average revenue at individual units — average revenue and marginal revenue differ when it comes to changes in demand and price relationship. If you lower the price of an item to sell more of the item, the average revenue goes down. If average revenue goes down, marginal revenue is necessarily lower than average revenue. This occurs because the average price of each item adjusts for all items sold when price goes down, while marginal revenue simply records diminishing returns in the relationship between units sold and revenue.
For instance, if you sell 100 items for $5 each but sell a 101 item for $4, average revenue changes from $5 (500/100) to $4.99 (504/101) for each item, while marginal revenue simply records a change of $4 on the last item, resulting in a lower value on that item that represented by average revenue. If price goes up, marginal revenue is higher than average revenue for the same reason.
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