Question

Why does marginal revenue decrease when total revenue increases? I understand how to calculate marginal revenue and total revenue and I've looked at images of the two curves but I don't understand the reason behind what's happening.  

Answer 1

For understanding the concepts let us understand first, of what marginal revenue refers to and what total revenue means. Post this, the reason why marginal revenue decreases even when total revenue increases will be described.

Total Revenue:-

Any firm or company for its survival has to look at the money it makes over a period of time by selling its products and services in the market. This translates into the concept of total revenue. Total revenue represents the value of total returns from selling a particular quantity of the product.

Also, it is worthy to note, that as a company goes on selling more products irrespective of the price that it charges, the total revenue will increase.

Marginal Revenue & Reason why it decreases even when Total Revenue Increases:-

On the contrary, marginal revenue refers to the revenue generated by a firm by selling an additional product in the market. It is the value difference between the cost of an additional product sold.

For example a company sells 1 shoe for 10$ and the next one for 8$ The Marginal revenue would be -2 indicating that for an additional quantity sold the company would have to sell it at a lower cost.

Each customer has a limited budget and would only be able to buy a particular amount of a given commodity. Further, to sell more goods in the market place, a company would need to reduce its prices to a particular point. This is why marginal revenue made by selling an additional item decreases even when total revenue would not.

In the example given above, to sell two goods to the customer, even when total revenue would be 18, because of the additional good sold the marginal revenue would decrease.

Conclusion:-

The conclusion which one can easily draw from this is, that because the price charged for selling an additional quantity of the product would have to be lower after a certain time, the marginal revenue arising from such operations would be lower.

In this case, even when the company would earn a total revenue, the marginal revenue would decrease and ultimately become negative respectively.

Please feel free to ask your doubts in the comments section if any.