The relationship between AR and MR depends on the type of market the firm operates in. Let’s analyze this step by step with clarity.
1. Perfect Competition
In a perfectly competitive market, firms are price takers, meaning they cannot influence the price.
AR = MR = Price (P), as every unit of the product is sold at the same price.
2. Monopoly or Imperfect Competition
In these markets, firms are price makers. The price decreases as output increases due to the downward-sloping demand curve.
Key Points:
- AR is always greater than MR.
- MR falls faster than AR and can even become negative.
- AR and MR curves slope downward.
- MR lies below AR.
- When MR is zero, then Total revenue is maximum. Beyond this, increasing production reduces total revenue.
Factors Influencing the Relationship
- Market Structure: Perfect competition has constant AR and MR, while monopoly causes MR to fall below AR.
- Elasticity of Demand:
- When demand is elastic, MR is positive.
- When demand is inelastic, MR is negative.
- Pricing Strategies: Firms in imperfect markets may use strategies like price discrimination, impacting the AR-MR relationship.
For Example
Perfect Competition
A farmer sells wheat at ₹20/kg. Whether they sell 1 kg or 100 kg, the price remains constant.
| Quantity | Total Revenue (₹) | AR (₹) | MR (₹) |
|---|---|---|---|
| 1 | 20 | 20 | 20 |
| 2 | 40 | 20 | 20 |
| 3 | 60 | 20 | 20 |
Monopoly
A firm selling luxury watches reduces the price as sales increase.
| Quantity | Total Revenue (₹) | AR (₹) | MR (₹) |
|---|---|---|---|
| 1 | 50 | 50 | 50 |
| 2 | 90 | 45 | 40 |
| 3 | 120 | 40 | 30 |
Uses
- Business Decisions: Understanding AR and MR helps firms decide the optimal output level to maximize revenue.
- Pricing Strategies: Firms analyze AR-MR to set competitive prices and boost profits.
- Elasticity Insights: Policymakers use AR-MR data to study consumer behavior and design economic policies.
In summary, the relationship between AR and MR is central to revenue analysis. While AR indicates the revenue per unit, MR reflects the revenue change with additional sales. The dynamics between the two depend on market structure and demand elasticity.