Monday, 28 December 2015

The law of supply definition | supply schedule | supply curve

As we have seen earlier, a supplier always tries to sell more and more commodities when the prices are high and reversely, restricts his supplies when prices start falling. This is the underlying fact of supply.

The law of supply employs this basic reality in its definition. It assumes that while other factors determining supply are constant, changes in price will result in changes of quantities supplied.

Law of Supply
The law of supply states that "all other factors remaining constant, an increase in price will result in an increase in quantity supplied and vice versa". In other words, the law of supply states that there is a direct relationship between price and quantity.

What is supply schedule
Supply schedule is a table or chart depicting the changes in quantities supplied at different prices of a commodity based on the above law of supply.

Suppose a supplier deals in the rice business. At a price of say Rs.50 per kg., the supplier will be putting into market all of his stock say 10,000 kg. of rice. If the price comes down to Rs.45 per kg., he will be supplying only say 8,000 kg. If the price further goes down to Rs.40, he will restrict more supplies and will be supplying only 5,000 kg. On the other hand, suppose price increases from Rs.50 to Rs.60 per kg., then he will try to procure more stocks from other sources and increase his supplies to 15,000 kg or like that. 

The same thing can be presented in the shape of a chart as shown below.

Supply Schedule chart

Price of Rice (Rs. Per kg)
Quantity of rice supplied (in Kg)

So, it is clear from the above supply schedule that the supplier decreases his supply quantity when prices fall. If you view the chart from bottom to top, you will realise that the supplier has increased his supplies whenever the price increased from previous price. The same thing can be illustrated through a supply curve also.

Supply Curve
A supply curve is the line or graph joining all the points of the supply levels at various prices of commodities.

Supply curve can be defined as the graphic representation of the relationship between price of a commodity and the quantities supplied by the supplier.

The quantities supplied are measured by the horizontal axis and prices of the commodity on the vertical axis.

From the above supply schedule of rice, we can draw the supply curve. We can start with the price as 'zero' and quantity supplied also as zero. So, the supply curve will be like this as represented below.

The supply curve will be raising upwards as and when prices increase, because the supplier will go on increasing  the supply quantity with every increase in price unless he is unable to do so because of other factors affecting supply.

Regarding factors affecting supply, you may view the information at this link.

Monday, 7 December 2015

What is Revenue or Income in its broader sense and types of revenue in economics

What is Revenue?
Revenue is the income of a business enterprise or any other organisations or governments. Revenue may be either in shape of sales proceeds from goods and services sold or in shape of receipts from other activities and sources of any enterprise or government. So, revenue includes sales income, fees received for services, interests received from investments and receipts from other sources like collection of taxes, duties, etc. It can include even donations received from others, funds received from other social activities, etc. All these receipts are collectively known as revenue.

Revenue is also refereed to as Gross Income or Gross Receipts.

Generally, revenue is measured as being receipts during a certain period of time - say, during a particular week, a particular month or in a year.

Different types of revenue in economics
Sometimes, revenue can be referred to as business revenue, government revenue or association revenue based on the nature of organisation or enterprise.

Business Revenue
Business revenue refers to income or receipts from normal business activities of any organisation. Any type of business that indulges in manufacturing and / or selling of products, or in providing services to its clients receives income either in form of sales or as fees for services. This income is known as 'business revenue'. The main point is that the income should be from their prime business activity. If one is indulged in rental business, then his business income is the rent received. If it is a financial institution, then their income will be from interest and other charges received in lending the loans.

This business revenue can be classified into two parts as Sales income and other income.

Sales Revenue or sales income
Sales revenue denotes the income received by way of sales of goods or services. For a manufacturer, it is income from sales of produced goods. For a grocery or merchant, it is income from sale of provisions or merchandise. For a banker, it can be the sale of loans. To a service provider like consultant or barber or cobbler, it is their service charges received. So, the sales revenue is the main business income.

Other Revenue or other income
While performing a business, it is possible that you may receive some income which is not related to your primary business activity. For example, you are running a manufacturing business. You sell your produce and receive the revenue. Now, you may not be spending all that income for your business. You may deposit some money in fixed deposits or invest in other investments. So, you will be receiving interest from these investments. It is not your sale income. It is to be termed as 'other income'. Similarly, you may sell some old machinery or assets and buy new ones. This sale of old assets is not your primary sale. It is your 'other income'.If you can rent a part of your building or any machinery to others for a short period, the rent received is also treated as 'other income'.

Government Revenue
Government revenue is entirely different from business revenue. Government revenue is the money received from various taxes and duties imposed by the government to meet out its expenditure in running the government and on spending in various development programmes of the country.
The receipts include collections from Income Tax, Goods and Service Tax, Sales Tax, etc. and from duties like Customs Duty, Excise Duty, Export / Import Duty, etc. The government revenue may also include income generated through financial and banking operations and through railways and tourism departments. All these are part of government revenue intended for spending on public works and for welfare of the country.

Association revenue (Social & non-profit organisations)
Association revenue is that type of revenue generated by non-profit organisations and public associations like cooperatives and NGOs. It is a fund created through non-business oriented activities for a common cause of the members of the organisation or for public welfare. The revenue generated includes membership fees of members, donations or charity fund received from outsiders and any financial help received from governments, etc. They may also generate revenue through sponsoring of cultural or any kind of programmes.

Concepts of Total Revenue, Average Revenue and Marginal Revenue
Now, let us study about another nomenclature of revenue terminology as total revenue, average revenue and marginal revenue.

Total revenue
Total revenue refers to the total receipts or income made in business during a period. It can be the whole income by way of sales of goods and services and may include other receipts also. But normally, it is treated as a product of total quantity sold multiplied by the cost of one unit of the product that is sold.
So, Total Revenue = Total quantity* cost per unit.
It can be represented as TR = Q*P where TR is total revenue, Q is quantity sold and P is cost or price per unit.

Average revenue
Average revenue is the value or cost of one unit of production or sales. Generally, businessmen arrive at average revenue by calculating the total expenses incurred by them in producing certain output which includes the value of their own minimum profit and other remunerations to staff and management. So this total expenditure is to be returned back to the business from the revenue that is received through sales. So, price is fixed by them accordingly. So, in most cases, the average revenue will be equal to the average cost of that product. Then only can they realise full production cost.

Average revenue is calculated by dividing the total revenue with the number of units sold.
Average revenue = Total revenue / total quantity sold
AR = TR/ Q where TR is total revenue and Q is quantity sold.

But, we have noticed already that TR is Q*P
So, if we substitute TR with Q*P, then AR = Q*P / Q = P. So, AR is same as P. This is applicable in most of the cases.

Marginal revenue
Marginal revenue is that amount of revenue which is received by sale of one more unit of the product.
Under normal circumstances, if cost or price remains constant, then Marginal revenue should be equal to Average revenue. But, mostly it is not so.
It is due to the fact that if there is plenty of supply, the prices will fall naturally. On the other hand, if there is short supply of goods, people tend to pay more for it than forego it. This is why the need for the concept of Marginal revenue arose.

Marginal revenue = P*(Q+1) - P*Q where P is the price or cost of one unit and Q is quantity.
So, MR = the revenue received by selling (Q+1) units minus revenue received by selling Q units.

For example, if a vendor sells each pair of slippers at Rs.100 per unit and suppose he sold 20 units on one day and 21 units the next day. So, the second day, he sold one extra unit. First day TR was 100*20 =2000 and second day's TR was 100*21 = 2100. His MR on second day is Rs.100.

Suppose he sold 20 units at a price of 100 on first day. But next day he was able to sell 21 units and earned only Rs.2080 as he had to sell extra pair at lower price. Then MR will be only Rs.80, because he earned an extra amount of only 80 (2080- 2000 = 80).

Some facts about Average Revenue and Marginal Revenue

  • Average revenue (AR) or Marginal revenue (MR) can increase or decrease depending upon circumstances.
  • If lesser quantities are produced, AR will increase as many costs are of fixed nature irrespective of quantity produced and so, price per unit will be fixed at higher rates. Contrarily, if more quantities are produced, AR will be lesser per unit.
  • Similarly, MR changes with changes in quantities at certain levels. If more units are sold after a certain point, the marginal revenue per unit will go on decreasing. If lesser quantities are sold than needed by market, then MR may increase per each unit sold.
  • Average Revenue is calculated as at a particular level of sales to know the average cost realised from sales and for comparing the cost price with sale price.
  • Marginal Revenue is calculated to study the impact of sale of each additional unit. It is used for controlling the quantities of sales to maintain price.
  • AR and MR will be the same as far as the seller is able to maintain the same sale price for any volume of sales.
  • If the seller is unable to maintain the same price for each levels of sales quantity, then AR and MR will vary.