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The Relationship Between Total and Marginal Values

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Total Values
Cost/Revenue

Total Revenue is price x quantity sold. (TR = P x Q) The slope of the TR curve A firm facing a downward varies atdemand curve is sloping each point. This because theprice to sell must lower amount added to TR from each sale is successive units of its slightly less than before. product. TR therefore rises A positive slope suggests at first but the rate at which TR is rising, a negative it rises begins to slow slope that TR is falling. down and will eventually fall.

TR
Output/Sales

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Cost/Revenue

TC

At Totalpoint the slope of this Cost (TC) Profit = TR TC is the the TR and TC costs are sum of fixed curves Maximum profit will be equal. At this point MC = (FC) and variable made where the MR since(VC).and MR are costs MC distance of the TR and the slopes between TR and TC are at their TC = FC + VC TC curves. (Students of greatest. calculus should recognise It cuts the vertical axis this!) a point indicating at the profit maximisation Hencelevel of fixed costs. occurs where MC = MR.

FC TR
Output/Sales

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Total and Marginal Values

Price

Ped = -1

At the pointnormal conditions, Marginal Revenue (MR) is Under where the MR cuts the horizontalto TR MRfacing thethe demand curve a= O. addition axis, as result Thatthe firm is downwardof to of selling one extra unit means that the addition TR from If the Done extra unit output. selling curve is sloping from left to right. was This implies thateach unit downward sloping, to sell for 0. This is the definition unitsold atelasticity of of a is increasing items demand. price a progressively lower price.a firmMR curve product The must Therefore the equivalent point liesaccept the D(AR) curve. under a lower price for on the D curve is where Ped = each successive unit. -1 AR = TR/Q. The area under the curve represents TR

D = AR
Sales

MR
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Total and Marginal Values

Price

Ped in this range is between infinity and -1

It follows that when MR is When price elasticity of negative,is elastic, the to TR demand the addition % must bein Qd is > % this is the change negative. If change in case such a reduction in price P. In then circumstances, a by 10% would lead to Qd would reduction in price of 10% rising by less than by more than 10% see D rising 10% meaning TR would fall. and TR would rise. The addition to TR must therefore Elasticity in this range of the be positive shown by the demand curve must therefore highlighted area on and MRor be between infinity the -1 curve. elastic.

D = AR
Sales

MR
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Total and Marginal Values

Price
When MR is negative, the addition to TR must be negative. If this is the case then a reduction in price by 10% would lead to Qd rising by less than 10% meaning TR would fall. Elasticity in this range of the demand curve must therefore be between 0 and -1 - inelastic

Ped in this range is between 0 and -1 D = AR

Sales

MR
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Cost / Revenue

TC

Putting the two together:

If a firm was to target revenue maximisation as an objective, If we put not necessarily this wouldthe two diagrams together we the profit correlate withcan see that profit maximisation occurs where maximising output revenuethe difference between where TC maximisation occursTR andTR is greatest (where MC 0) is at a maximum (MR = = MR)

TR
Output/Sales

MC

D = AR
Q1 Q2

Output/Sales

MR
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