Revenue Analysis and Pricing

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 Revenue
Total amount of money value received by a
firm or an industry by selling the goods and
services is known as the revenue.
For example if a firm produce 100 units of
commodity per day and sells it at Rs.20 per
unit then its total revenue is Rs. 2000 per day.

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Revenue Types

The revenue can be classified into

three category such as ;
a.Total Revenue (TR).
b.Average Revenue (AR).
c.Marginal Revenue (MR).
Each curve have different
characteristics for different market
structure. 3
Here we discuss characteristics of TR, AR and MR
under perfect competitive and monopoly market
structure.
GENERAL CONCEPT OF TR, AR AND MR
A. Total Revenue (TR):
Total sum of money value received from the sales of
various quantities of output of product produced
during a given period of time at certain price level is
known as total revenue of a firm or an industry for
that time period.
It can be obtained by multiplying total output sold
(Q) by the corresponding price (P).
i.e. TR = P × Q
B. Average Revenue (AR):
Per unit revenue of a product is known as average
revenue. We obtain AR by dividing (TR) by the
corresponding quantity sold (Q).

i.e.

C. Marginal Revenue (MR):

An additional amount of money received from the
sells of one additional unit of a product or output.

i.e.
Where, TRn is he total revenue obtained from the
sales of nth unit of output and TRn-1 is the total
revenue obtained from the sales of (n-1) th unit of
output.
In other words, marginal revenue is the change in
total revenue due to change in the quantity sold on
the market by one unit.

i.e.
Where, Δ = change
Δ TR = change in total revenue
Δ Q = change in quantity sold in the market.
 Revenue Curves Under Perfect Competition
Market
Perfect competition is a market structure in which
a large number of sellers sell the homogeneous
product to a large number of buyers.
There are large number of buyers and sellers so
that no one individual buyer or seller can influence
the smooth functioning of the market.
That means neither individual seller nor buyer can
change the price of the product. In this structure of
the market firms are the price taker not price makers.
In perfectly competitive market a firm or an
industry sell its output at given price.
The price is determined by the market , i.e. the
intersection of market demand and market supply
curves .
The total, average and marginal revenue of a
competitive firm are illustrated as follows;
a. Total Revenue (TR):
Total amount of money value received by a
producer by selling various quantities of the
product in the market at constant price is known
as TR in case of perfectly competitive market.
TR is obtained by multiplying amount of output
sold by the given price determined in the market by
intersection of market demand and market supply
curve.
i.e. TR = Q × P Where, Q= amount of product sale
P= Market Price which is constant.
TR increases at the same rate because, every
additional unit of the commodity is sold at the
same price. In this type of market firms are price
taker not price maker.
It can be explained with the help of following
table and graph.
 Total Revenue Under Perfect Competition
Units of Output (Q) Per Unit Price (P) Total Revenue (TR)
0 10 0
1 10 10
2 10 20
3 10 30
4 10 40
5 10 50

•In above table total revenue (TR ) is obtained by

multiplying output (Q) and Price (P). When output is
zero TR also zero. TR is Rs. 10, 20, 30, 40 and 50 for
the 1, 2, 3, 4 and 5 units of sale respectively, where
price is constant at Rs. 10.
In the above table as increase in sell of output total
revenue also increasing, but the rate of increase in
total revenue
constant. TRis TR
Graphically, 50

40

30

20

10

O
1 2 3 4 5 Output
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b. Average Revenue (AR):
 Per unit revenue obtained by a seller by selling
product at market price in the market in certain time
period is known as AR for that time period of that
seller or producer.
It is calculated by dividing total revenue (TR) by
corresponding quantity sold (Q) in the market at market
price (P).
i.e. AR = TR/Q
i.e. AR =( P×Q)/Q
i.e. AR = P
Therefore, another name of AR is the average market
price of the product. Since, price is constant in perfect
competition market and hence, AR is also constant .
It can be explained with the help of
following table;
Average Revenue Under Perfect Competition
Units of Per Unit Price Total Revenue Average Revenue
Output (Q) (P) (TR) (AR) = TR/Q

0 10 0 -

1 10 10 10

2 10 20 10

3 10 30 10

4 10 40 10

5 10 50 10
In the above table as increase in sells of output of
the product Average Revenue (AR) remains
constant i.e. Rs. 10 for first unit to fifth unit
output. of
Above information shows that AR is constant and
equal to the price for all level of output.
In the following figure average revenue curve is
found by plotting the combination of points of the
quantity sold on the horizontal axis and
corresponding AR on the vertical axis.
AR curve is a horizontal straight line at the different
level of output sold at given price. It shows that AR
is constant and equal to the price for all level of
output, i.e. AR = P.
Graphically
,
AR

50

40

30

20

10 AR

O
1 2 3 4 5 Output
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c. Marginal Revenue (MR):
Marginal revenue is the change in total
revenue in response to the change in quantity
sold. It is calculated by dividing the change in
total revenue (ΔTR) by the change in quantity
sold (ΔQ).
In case of perfectly competitive market
marginal revenue (MR) remains constant and
equal to the market price for all level of
output sold, i.e. MR = P.
It can be explained with the help of following
table and graph.
 Marginal Revenue in Perfect
(P) Competition
Units of Per Unit Price Total Revenue Average Marginal
Output (Q) (TR) = P × Q Revenue (AR) Revenue
= TR/Q (MR) =
ΔTR/ΔQ
0 10 0 - -
1 10 10 10 10
2 10 20 10 10
3 10 30 10 10
4 10 40 10 10
5 10 50 10 10
•In the above table as increase in output sold at market
price TR increases at constant rate . But MR remains
constant i.e. Rs. 10. which is equal to price.
•Form above table we conclude that Price, AR and MR
are same i.e. Rs. 10. that means P = AR = MR.
Graphically
,
MR
50

40

30

20

10 MR

O
1 2 3 4 5 Output
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In the above figure MR is the slope of the TR. The MR
curve is found by plotting the MR on y-axis and quantity
sold on x-axis.
The MR curve is also horizontal to the x-axis as of the
AR. It shows that AR and MR are overlapped and equal to
the price in perfectly competitive market.
Relationship between TR, AR and MR under perfectly
competitive market
TR increases at the rate of AR or MR for all level of sales.
AR and MR are equal and constant for
all level of sales.
AR and MR both are equal to the price.
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 Pricing
• Pricing denotes revenue to seller
• Perceived Value to buyer
• Pricing strategy Important for new product,
modified product, new market, new market
segment, objective of firm
• Basic determinants are supply and demand

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 PRICING PRACTICES

General Considerations To Be Kept In Mind While

Formulating A Pricing Policy:
• Objectives of business- Notwithout considering its
impact on all objectives
• Market structure
• Competitor’s strategy
• Price Sensitivity/ elasticity(even for monopolist)
• Conflicting Interests of Manufacturers and
Middlemen, consumers
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 General Considerations

• Routinisation of Pricing- Speed required in

decision-making, quality of data available,
competitive market
• Role of Non Business Groups in pricing
Decisions- Government, political
considerations , farmers and business lobbies,
Trade Unions etc

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 Types of Pricing
• COST BASED PRICING
• BASED ON FIRM’S OBJECTIVE
• COMPETITION BASED PRICING
• PRODUCT LIFE CYCLE PRICING
• CYCLICAL PRICING
• MULTIPRODUCT PRICING
• ADMINISTERED PRICING

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 I. COST BASED PRICING
• Cost Based Pricing
– Cost Plus or Mark Up
– Marginal Cost pricing
– Target Return pricing

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 Cost Based Pricing
i. Cost Plus / Full Cost/Average Cost/
Mark-up Pricing
Price set to cover cost plus a percentage
for predetermined profits.
P= AC+ m
where, m =mark-up percentage

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• Mark up depends on target rate of return,
degree of competition, price elastiicty,
substitutes etc

- Most common
• Simple to fix the price
• More defensible on moral grounds

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 Cost Based Pricing
Drawbacks:
-Historical cost rather than current cost data is
used, which may lead to over/under pricing
-Inappropriate if variable cost fluctuates frequently
-Some critics say it ignores demand side (But firm
determines mark up on the basis of ‘what the
market can bear’)
- Ignores marginal cost as it uses average cost
- Not suitable if competition is tough or when
entering new market

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 Marginal Cost Pricing
ii. Marginal Cost Pricing/ Incremental cost
pricing:
Price of product = Variable cost plus a profit
margin.
Only those costs which are directly attributable to
the output of a specified product
Here price will be lower than the full cost pricing.
:WHY?
•
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 Marginal Cost Pricing
• All past outlays are historical and a firm should
deal solely with anticipated revenues and
outlays
• Firm is more interested in future changes in cost
due to changing decisions
• Unlike fixed costs , MCs are controllable in the
short run
• Total costs can not be of use in case of multi-
product/ markets/ process situations

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 Marginal Cost Pricing
Useful to beat competition
Also, to enter the market
Used for pricing public utility where profit is not
the motive
Weaknesses:
• Can only be a short term strategy (as it omits
fixed costs)
• Can be only restricted to pricing of specific
orders
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 Cost Based Pricing

Iii) Target Return Pricing

• Producer rationally decides the minimum
rate of return which must be earned by the
product
• Methodology similar to the above, but
margin is decided on the basis of target
rate of return, on the basis of experience,
consumer’s paying capacity, risk involved
etc
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 II. Based on Firm’s Objective
• Pricing Based on Firm’s objective
-Profit Maximisation- considers total cost
-Sales Maximisation- should adopt
competitive pricing, say marginal pricing

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 III. COMPETITION BASED
PRICING
i. Penetration Pricing : Low price when
entering new market dominated by
existing players (Nirma, Deccan Air)
ii. Entry Deterring- Price kept low to make
market unattractive for competitors
(Common in oligopoly)

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 Competition Based Pricing

iii. Going Rate Price:

Why?
Firms do not want price wars
Small/ new firms may not be sure of the
effect of charging a different price
Products are close substitutes with high
cross elasticity

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 Competition Based Pricing

Popular in monopolistic and oligopoly

markets because
a) of low product differentiation and
b) for consumer the cost of switching is
minimal
• Uniform price of packaged water or fruit
juice

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 IV. PRICE DISCRIMINATION
First degree Price Discrimination
-Each unit of output
is sold at a different price
or each consumer is charged
a different price .

Entire consumer’s surplus wiped out

Price

Quantity
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 Second Degree Price
Discrimination
Seller gets part of
D consumer’s surplus.
Highest price of OP1
A for OQ1 units.
P1
Price is OP2 for Q1Q2
P2 B units
Price

Lowest price of OP3 for

C
P3 the next Q2Q3 units.
Monopolist maximises
D revenue at
TR= (OQ1*AQ1)+
(Q1Q2*BQ2)+
O (Q2Q3*CQ3)
Q1 Q2 Q3
Demand 38
 V. PRODUCT LIFE CYCLE
PRICING
• Refers to different pricing strategies for a
product depending on the different stages
of its life cycle
• Each phase is unique- different demand
patterns and competition
• So setting same price will mean less than
optimum revenue

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V. PRODUCT LIFE CYCLE
PRICING
Sales revenue Curve
1.Introduction
2.Growth
3.Maturity
4.Saturation
5. Decline

2 3 4 5
1

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PRODUCT LIFE CYCLE PRICING
i) New Product:
a)Skimming Policy
: Charging very high initial price and super normal
profits-Lower price during maturity
• The first ball pens introduced in 1945 cost 80
cents to produce but were priced at $12.50.
• Initial high prices of computers
• 1st day movie tickets

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PRODUCT LIFE CYCLE PRICING
Why?
• Demand is likely to be less price-elastic in initial
stages
• If life of product is likely to be short, the producer
can get as much as possible as fast as possible
• The policy can lead to introduction of product for
lower segments later.
• High initial price may finance the heavy initial
costs of introducing a new product when other
sources of finance may not be available

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PRODUCT LIFE CYCLE PRICING

Benefits of lower cost due to growing

volumes and technological development
allows for lowering of prices at a later
stage.

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PRODUCT LIFE CYCLE PRICING
b) Low Penetration Price: Close to customary
price- only minor adjustments required
eventually.
• Objective of low penetration pricing is to keep off
competition
Appropriate where:
• Sales respond strongly to lower prices
• High volumes lead to lower costs
• Product acceptable for mass consumption
• To capture a large share of market quickly
where there is a threat of potential competition
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PRODUCT LIFE CYCLE PRICING

High Skimming price

Low penetration Price

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PRODUCT LIFE CYCLE PRICING
ii) Rapid Growth- Stable price policy for
sustained growth
iii) Maturity: Growth occurs at diminishing
rate- firm may introduce minor quality
changes with higher prices
iv) Saturation- Lower prices and discounts to
clear stocks
v) Decline- Wind up
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 PRODUCT LIFE CYCLE
PRICING
Product Bundling- Two or more products
bundled together for a single price
Strategy for both new and mature/
declining product
Saves cost of spreading awareness
Captures part of consumer surplus
Regain customers during decline phase
TOI and ET
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 PRODUCT LIFE CYCLE
PRICING
Perceived Value pricing: Psychological
pricing depending on consumer’s
perception of utility- Tanishq jewelry,
Parker pens etc-by creating a hype about
high quality
Value pricing- variant of iv. Try to create
high value and charge a low price ie., price
charged is lower than perceived value
e.g., heavy discounts
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 Product Life Cycle Pricing
Loss Leader Pricing: Here, multi product
firms sell one product at a low price and
compensate the loss by another product
Charge lower price for a good that is durable
and has a high value but high price for the
complementary, low value consumable
(HP printers and cartridges)

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 VI.CYCLICAL PRICING
Rigid or flexible?
• Rigid price means Firms selling a stable price
irrespective of the business cycle phase
(Flexible pricing is meaningless for eatables etc
where demand does not change with cycles;
dangerous in case of durables as consumers
will wait for the next recession to buy durables)

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VII. MULTIPRODUCT PRICING
• Tata Sons produces steel as well as trucks and
cars where steel is used as input
• Demand Interdependence: A firm can produce
goods which are substitutes(Zen and wagon R)
or complements.
• If substitutes, either price them the same(coke
and Thums Up) or resort to perceived value
pricing; or even, going price strategy
• One firm’s output may be another’s input

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 MULTIPRODUCT PRICING
Ramsay pricing
• A firm should fix the price close to the
marginal cost for product which has high
elasticity and charge substantial margins
for products which have low elasticity.
Price deviations from marginal cost should
be inversely proportional to the price
elasticity of the product,
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 TRANSFER PRICING
Transfer Prices are the charges made when a
company supplies goods, services, or financial
services to its subsidiary or sister concern.
Globally, 60% of transactions are between
associated companies. MNCs are required to set
Transfer Prices for supply of goods, technical
know-how, marketing rights etc from parent to
subsidiary or one subsidiary to another .

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 TRANSFER PRICING
Govts keep strict watch on this in order to check
tax evasion as companies try to reduce tax
incidence globally by transferring higher income
to low tax jurisdiction and higher expenditure to
high tax countries
• In general regulatory authorities agree on “arms
length price”- i.e., same price should be charged
whether the transaction is between related or
unrelated parties

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 VIII. PEAK LOAD PRICING

Peak Load Pricing

• Higher price at peak level of use and lower

at slack time
Examples-
Electricity, telephone charges, air fares

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 Guidelines for Price Fixing

Bates and Parkinson’s Guidelines for Price

Fixing:
• Find out how your costs compare with your
competitors’.
• Keep an eye on the market-if orders are difficult
to come by, drop prices; if easy, raise.
• Goodwill of customers is probably gained more
through advertising than keeping price low

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• If you can sell all your output at prices that give
you substantial profit, consider expanding
production.
• If you find that your sales vary over seasons,
adjust prices
• If your prices seem to be higher than those of
your competitors although they scarcely cover
costs, you may need to take a re-look at your
production methods and organisational process

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• If you are one of very few producers in the
industry, what your competitors are likely
to do may be a more important
consideration in fixing prices rather than
your costs.
• If you are a monopolist and follow a pricing
policy that is seen as being against public
interest, beware of government action and
potential competition…

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