Marginal revenue is the net revenue earned by selling an additional unit of the product. In other words, marginal revenue is the addition made to the total revenue by selling one more unit of a commodity. Putting it in algebraic expression, marginal revenue is the addition made to total revenue by selling n units of a product instead of n – 1 where n is any given number.
If a producer sells 10 units of a product at price Rs. 15 per unit, he will get Rs. 150 as the total revenue. If he now increases his sales of the product by one unit and sells 11 units, suppose the price falls to Rs. 14 per unit. He will, therefore, obtain total revenue of Rs. 154 from the sale of 11 units of the good. This means that 11th unit of output has added Rs. 4 to the total revenue. Hence Rs. 4 is here the marginal revenue.
Total revenue when 10 units are sold at price of Rs. 15 = 10 x 15 =Rs. 150
Total revenue when 11 units are sold at price of Rs. 14 = 11 x 14 = Rs. 154
Marginal revenue = 154- 150 = Rs. 4
The word net in the first definition of marginal revenue given above is worth noting. The full understanding of the word ‘net’ in the definition will reveal why the marginal revenue is not equal to the price. The question is, taking our above numerical example, why the marginal revenue due to the 11th unit is not equal to the price of Rs. 14 at which the 11th unit is sold. The answer is that the 10 units which were sold at the price of Rs. 15 before will now all have to be sold at the reduced price of Rs. 14 per unit.
This will mean the loss of one rupee on each of the previous 10 units and total loss on the previous 10 units due to price fall will be equal to Rs. 10. The loss in revenue incurred on the previous units occurs because the sale of additional 11th unit reduces the price to Rs. 14 for all.
Thus in order to find out the net addition made to the total revenue by the 11th unit, the loss in revenue (Rs. 10) on previous units should be deducted from the price of Rs. 14 at which the 11th unit is sold along with others. The marginal revenue in this case will, therefore, be equal to Rs. 14 – 10 = 4. Marginal revenue is thus less than the price at which the additional unit is sold.
It is clear from above that marginal revenue can either be found directly by taking out the difference between total revenue before and after selling the additional unit, or it can be obtained by subtracting the loss in revenue on previous units due to the fall in price from the price at which the additional unit is sold.
Therefore, marginal revenue = difference in total revenue in increasing sales from n – 1 units to n units.
= price of the additional unit minus loss in revenue on previous units resulting from price reduction.
It follows from above that when the price falls as additional unit is sold, marginal revenue is less than the price. But when the price remains the same as additional unit is sold, as under perfect competition, the marginal revenue will be equal to average revenue, since in this case there is no loss incurred on the previous units due to the fall in price.
The relationship between average revenue and marginal revenue is the same as between any other average and marginal values. When average revenue falls marginal revenue is less than the average revenue. When average revenue remains the same, marginal revenue is equal to average revenue.
If TR stands for total revenue and Q stands for output, then marginal revenue (MR) can also be expressed as follows:
MR = ∆TR/∆Q
∆TR/∆Q indicates the slope of the total revenue curve.
Thus, if the total revenue curve is given to us, we can find out marginal revenue at various levels of output by measuring the slopes at the corresponding points on the total revenue curve.
Average and Marginal Revenue under Imperfect Competition
The meaning of the concepts of total, average and marginal revenues under conditions o’ imperfect competition will become clear from Table 1. As has been stated above, when imperfect competition prevails in the market for a product, an individual firm producing that product faces a downward sloping demand curve. In other words, as a firm working under conditions of imperfect competition increases production and sale of its product its price falls.
Now, when all units of a product are sold at the same price, the average revenue equals price. How marginal revenue can be obtained from the changes in total revenue and what relation it bears to average revenue will be easily grasped.
It will be seen from the Col. Ill of the table that price (or average revenue) is falling as additional units of the product are sold. Marginal revenue can be found out by taking out the difference between the two successive total revenues. Thus, when 1 unit is sold, total Y revenue is Rs. 16. When 2 units are sold, price (or AR) falls to Rs. 15 and total revenue increases to Rs. 30.
Marginal revenue is therefore here equal to 30-16 = 14, which is recorded in Col. IV. When 3 units of the product are sold, price falls to Rs. 14 and total revenue increases to Rs. 42. Hence marginal revenue is now equal to Rs. 42-30 = Rs. 12 which is again recorded in Col. IV.
Likewise, marginal revenue of further units can be obtained by taking out the difference between two successive total revenues. Marginal revenue is positive as long as total revenue is increasing. Marginal revenue becomes negative when total revenue declines. Thus when in our table 2 quantity sold is increased from 9 units to 10 units the total revenue declines from Rs. 72 to 70 and therefore the marginal revenue is negative and is equal to -2.
It may be noted that in all forms of imperfect competition, that is, monopolistic competition, oligopoly and monopoly, average revenue curve facing an individual firm slopes downward as in all these market forms when a firm lowers the price of its product, its quantity demanded and sales would increase and vice versa.
The case, when average revenue (or price) falls when additional units of the product are sold in the market is graphically represented in Fig. 1. In Fig. 1 it will be observed that average revenue curve (AR) is falling downward and marginal revenue curve (MR) lies below it.
The fact that MR curve is lying below AR curve indicates that marginal revenue declines more rapidly than average revenue. When OQ units of output are sold, AR is equal to QH or OP and MR is equal to QS. When OM units of the product are sold, marginal revenue is zero. If the quantity sold is increased beyond OM, marginal revenue becomes negative.
Average and Marginal Revenue under Perfect Competition
When there prevails perfect competition in the market for a product, demand curve facing an individual firm is perfectly elastic and the price is beyond the control of a firm, average revenue remains constant. If the price or average revenue remains the same when more units of a product are sold, the marginal revenue will be equal to average revenue.
This is so because if one more unit is sold and the price does not fall, the addition made to the total revenue by that unit will be equal to the price at which it is sold, since no loss in revenue is incurred on the previous units in this case Consider the following table:
In the above table, price remains constant at the level of Rs. 16 when more units of the product are sold. Col. Ill shows the total revenue when various quantities of the product are sold. Total revenue has been found out by multiplying the quantity sold by the price.
It will be found from taking out the difference between two successive total revenues that marginal revenue in this case is equal to the price i.e., Rs. 16. Thus, when two units of the good are sold instead of one, the total revenue rises from Rs. 16 to Rs. 32, the addition made to the total revenue i.e. marginal revenue will be equal to Rs. 32 -16 = Rs. 16.
Similarly, when three units of the product are sold, the total revenue increases to Rs. 48, and the marginal revenue will be equal to Rs. 48 -32 = Rs. 16 Likewise, it will be found for further units of the product sold that marginal revenue is equal to price. The case of perfect competition when for an individual firm average revenue (or price) remains constant and marginal revenue is equal to average revenue is graphically shown in Fig. 2 Average revenue curve in this case is a horizontal straight line (i.e., parallel to the X-axis).
Horizontal-straight-line average revenue curve (AR) indicates that price or average remains the same at OP level when quantity sold is increased. Marginal revenue (MR) curve coincides with average revenue (AR) curve since marginal revenue is equal to average revenue.