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Defining Marginal Revenue for a Firm with Market Power
Marginal revenue (MR) is the change in total revenue (TR) that a firm gets from
selling one more unit of its product.
For a monopolist, marginal revenue is always less than price because to sell an additional
unit of its product, a firm has to lower the price not only for the marginal unit but for all
units.
Average revenue (AR) is the total revenue divided by output. AR is the per unit revenue,
and for a monopolist it is always the price.
In the example on the left, assume that the
firm has a monopoly restaurant at an airport.
It can sell different quantities of meals at
different prices, as shown in the two far left
columns. It has a down-sloping demand curve.
You then multiply P x Q at each point to get
total revenue (TR).
Marginal revenue (MR) is the change in
total revenue at each price/output
combination.
There are some things that you should
remember about the MR/TR relationship:
1. TR increases for awhile then begins to
decrease. At first, as the price falls, the
firm sells more dinners that more than
compensate for the lower price, but later
the additional meals do not make up for
lost revenue from selling all of them at a
lower price.
2. When TR is maximum, MR is zero.
3. When MR becomes negative, TR is falling.
From the production schedule on the previous
page, you can draw a demand curve which
tells you the quantity sold at any given price.
The demand curve is also called the average
revenue (AR) curve. Average revenue is
total revenue/quantity.
For a monopolist, average revenue is the same
as the product price.
The most important concept to remember in
this lesson is that marginal revenue is always
less than the price for a monopolist. The
marginal revenue curve is depicted on the left.
The reason that it is less than the price at all
output levels is that if the firm wants to sell
more dinners, it has to lower the price for all
customers. For a competitive firm, marginal
revenue is always the price because one
additional sale increases total revenue by the
price. For a monopolistic firm, total revenue
changes by something less than the price
because when it lowers the price, it has to
lower it for all customers.