Total revenue is the full amount of total sales of goods and services. It is calculated by multiplying the total amount of goods and services sold by the price of the goods and services. Marginal revenue is directly related to total revenue because it measures the change in the total revenue with respect to the change in another variable.
Total revenue is important because, in the effort to grow profits, businesses strive to maximize the difference between their total revenues and total costs. Understanding the subtleties of the relationship between revenues and costs distinguishes the best business managers because while increasing production leads to an increase in sales and total revenue, there are also costs involved with increasing production.
In addition, the calculation of total revenue frequently takes timetables into account. A restaurateur, for example, might tabulate the number of hamburgers sold in an hour, or the number of orders of medium-sized french fries sold throughout the business day. In the latter case, the total daily revenue would be the quantity (Q) of fries sold—say 300, multiplied by the price (P) per unit—say $2, per day. Therefore, the simple formula for this calculation would be:
With the values plugged into the equation, Total revenue is $600—figured by the simple arithmetic of 300 X $2.
Real Life Example
Consider what happens if the restaurateur drops the price of a unit of French fries to $1, and he heavily advertises the new discounted price. This could result in a bump in sales—let’s say to 500 units per day. Consequently, the total revenue bumps up to $500 in sales.
Total revenue changes with respect to price and quantity can be visually demonstrated on a graph, in which a demand curve is drawn, that signals the price and quantity that would maximize total revenue.
Marginal revenue measures the change in revenue that results from a change in the full amount of goods or services sold. It indicates how much revenue increases for selling an additional unit of a good or service. To calculate marginal revenue, divide the change in total revenue by the change in the quantity sold. Therefore, the marginal revenue is the slope of the total revenue curve. Use the total revenue to calculate marginal revenue.
For example, suppose a company that produces toys sells one unit of product for a price of $10 for each of its first 100 units. If it sells 100 toys, its total revenue would be $1,000 (100 x 10). The company sells the next 100 toys for $8 a unit. Its total revenue would be $1,800 (1,000 + 100 x 8).
Suppose the company wanted to find its marginal revenue gained from selling its 101st unit. The total revenue is directly related to this calculation. First, the company must find the change in total revenue. The change in total revenue is $8 ($1,008 - $1,000). Next, it must find the change in the toys sold, which is 1 (101-100). Thus, the marginal revenue gained by producing the 101st toy is $8.