Marginal revenue is the additional revenue a firm earns by selling one more unit of a good or service. It represents the change in total revenue resulting from a one-unit increase in the quantity sold. Marginal revenue is a crucial concept in understanding how firms make output and pricing decisions across various market structures.
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Marginal revenue is the derivative of total revenue with respect to quantity, representing the change in total revenue from selling one more unit.
In a perfectly competitive market, marginal revenue is equal to the market price because a firm can sell additional units without affecting the price.
For a monopolist, marginal revenue is less than the market price because additional units can only be sold at a lower price, reducing the revenue per unit.
Firms in imperfectly competitive markets, such as monopolistic competition and oligopoly, face a downward-sloping demand curve, leading to marginal revenue being less than the market price.
Marginal revenue plays a crucial role in a firm's profit-maximizing output decision, as the firm will produce up to the point where marginal revenue equals marginal cost.
Review Questions
Explain how marginal revenue relates to a firm's pricing and output decisions in a perfectly competitive market.
In a perfectly competitive market, where firms are price-takers, the marginal revenue a firm earns from selling an additional unit is equal to the market price. This is because the firm can sell as many units as it wants at the prevailing market price without affecting that price. As a result, the firm's profit-maximizing output decision is to produce up to the point where its marginal revenue (equal to the market price) equals its marginal cost, as this maximizes the firm's profits.
Describe how a monopolist's marginal revenue differs from the market price and how this affects the firm's output decision.
For a monopolist, marginal revenue is less than the market price because the firm must lower the price on all units sold in order to sell an additional unit. This is due to the firm's downward-sloping demand curve, which means that additional units can only be sold at a lower price. As a result, the monopolist will produce at the output level where its marginal revenue equals its marginal cost, which is lower than the output level that would maximize social welfare.
Analyze how marginal revenue influences the efficiency of perfectly competitive markets compared to monopolistic markets.
In a perfectly competitive market, where marginal revenue equals the market price, the firm's profit-maximizing output decision leads to an efficient allocation of resources, as the market price reflects the true social cost of production. However, in a monopolistic market, the monopolist's marginal revenue is less than the market price, leading the firm to produce at a lower output level and charge a higher price than would be socially optimal. This results in a deadweight loss and a less efficient allocation of resources, as the market price no longer reflects the true social cost of production.
A graphical representation of the relationship between the price of a good and the quantity demanded of that good, showing how much consumers are willing to buy at different prices.