Why is AR Greater than MR of a Monopoly Firm? | Economics

Get the answer of: Why is AR Greater than MR of a Monopoly Firm?

For a firm under perfect competition, MR = AR. In fact, when price remains fixed, AR, MR and price are all equal to one another. Since a monopolist is the sole seller of a commodity, its demand curve is the same as the market demand curve for that product.

The market demand curve, which shows the total quantity that buyers will purchase at each price, also shows the quantity that the monopoly firm will be able to sell at each price. This means the monopolist, unlike the perfectly competitive firm, faces a negatively sloped demand curve. This, in its turn, means that there is a trade-off between the price it charges and the quantity it sells. Sales volume can be increased only if price is cut, and price can be increased only if sales are reduced.

Average Revenue and Marginal Revenue:

From the market demand curve we can easily derive the monopolist’s AR and MR curves. When the monopolist charges the same price for all units sold, its AR is identical with the price it charges. This means that the market demand curve is also the firm’s AR curve.

Since the monopolist’s demand curve is downward sloping (from left to right), it must lower the price that it charges on all units in order to sell an extra unit. If the monopolist wants to sell one extra unit, it has to reduce price not only of the last unit, but also of the earlier units (which could be sold at higher prices). So, more revenue loss is inevitable. Whether total revenue will increase or fall as a result of price cut depends on price elasticity of demand.

So, it clearly follows that the addition to its revenue resulting from the sale of an extra unit is less than the price that it receives for that unit (less by the amount that it loses as a result of cutting the price on all the units that it succeeds in selling). This means the MR of the monopolist is less than the price at which it sells its output.

Since MR is the change in TR associated with the sale of one more unit of output, MR is positive whenever TR is increased by selling more, but is negative whenever TR is reduced by selling extra units. Whether TR will increase or decrease, i.e., MR will be positive or negative depends on price elasticity of demand.

As Lipsey has put it, “Over the range in which demand curve is elastic, TR rises as more units are sold; MR must therefore be positive. Over the range in which the demand curve is inelastic, TR falls as more units are sold; MR must therefore be negative”.

The truth is that MR is less than p or AR in monopoly. This is so because p must be lowered to sell an extra unit. This is an important contrast with perfect competition.

Since a firm under perfect competition is a price-taker and can sell all it wants at the given market price in perfect competition, the firm’s MR from selling an extra unit of output is equal to the p at which that unit is sold. In contrast, the monopoly firm is faced with a negatively sloped demand curve. So, it has to reduce its p to be able to sell more units.