Question

Explain why marginal revenue is always less than average revenue(price) when demand is less than perfectly elastic.

Answer 1

When demand is less than perfectly elastic, change in price and quantity are not propotionate. Either a proportionate fall in price causes a less than proportionate rise in demand or an increase in price causes a less than proportionate fall in demand. Also, we know AR is that concept of Revenue which is always equal to price.

Now MR is the incremental revenue obtained with a change in quantity.

Consider the case of a rise in amount sold

For TR, there are two effect, a proportionate price fall (to sell more price must fall) and a less than proportionate quantity increase (output sold increases) such that TR is falling, as a result of which MR is falling in net. We have the effect of price fall in this (similar for AR) called the price effect but an opposing positive effect of quantity rise called the output effect embedded.

Thus there is a price effect such that an additional unit sold has a MR which is lower than the price because it will get less revenue for previous units as well.

Vice versa for fall in amount sold.. Thus MR curve especially in imperfect competition markets are below price.

In a perfect competition structure, there is no price effect as the firms can sell all they want at the prevailing price and thus is a special case when P=MR=AR.

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