The goal of a business is to maximize its profits by selling products or services to generate the highest level of revenue for the lowest possible cost. The total monetary value of all of the company’s sales is called total revenue. It is calculated by multiplying the number of units of product or service that were sold by the amount charged for each of those units.
The volume of units sold and total revenue are driven by market demand. Along with factors such as the quality of the product or service and competition in the marketplace, the demand for a specific product or service is affected by its price. As the price increases, the demand generally falls, and as the price decreases, the demand usually rises. This economic push and pull results in what is called elasticity of demand.
Elasticity of demand indicates how much the demand for a product or service changes based solely on a change in its price. If there is a strong correlation between price and demand, a change in price will cause a significant change in demand. Assessing the elasticity of demand will help a business determine a final price point, and it has a direct relationship to the concept of marginal revenue.
Marginal revenue is the change in total revenue received from the last additional unit sold. If a firm is operating in a competitive market environment and has found that demand for its goods or services is elastic, then the marginal revenue the firm would receive for selling one additional unit of good or service would remain constant or unchanging. If the company operates with inelastic demand or in a monopolistic or blended economy, however, it would find that its total revenue would be negatively affected by the major price reduction that it would have to apply to increase demand and maximize profits.