Marginal Revenue

Definition

Marginal revenue is the additional revenue a firm earns from selling one more unit of its product. It represents the change in a firm's total revenue when it increases its output by one unit. Marginal revenue is a crucial concept in understanding how firms make decisions about production, pricing, and profit maximization across various market structures.

5 Must Know Facts For Your Next Test

1. In a perfectly competitive market, the marginal revenue for a firm is equal to the market price, as the firm is a price-taker and cannot influence the market price.
2. For a monopoly firm, the marginal revenue is less than the market price because the firm must lower the price to sell an additional unit, reducing the revenue on all previous units sold.
3. Marginal revenue is a key factor in a firm's decision-making process, as it helps determine the optimal output level that maximizes profit.
4. In the short run, a firm will continue to produce as long as the marginal revenue is greater than or equal to the marginal cost of production.
5. In the long run, firms will enter or exit the market based on whether the market price is above or below the minimum point of the long-run average cost curve.

Review Questions

• Explain how marginal revenue relates to a firm's output decisions in a perfectly competitive market.
  • In a perfectly competitive market, a firm's marginal revenue is equal to the market price. This means that the firm can sell an additional unit of its product at the prevailing market price without affecting the price. As a result, the firm will continue to produce up to the point where its marginal revenue (market price) is equal to its marginal cost, as this will maximize its profit.
• Describe how a monopoly firm's marginal revenue differs from its market price and how this affects the firm's profit-maximizing output decision.
  • For a monopoly firm, the marginal revenue is less than the market price because the firm must lower the price to sell an additional unit, reducing the revenue on all previous units sold. This means that the monopoly firm will produce at a lower output level than a perfectly competitive firm, as it will maximize profit where its marginal revenue is equal to its marginal cost, which occurs at a lower output level than the competitive market price.
• Analyze how marginal revenue influences a firm's long-run entry and exit decisions in a perfectly competitive market.
  • In the long run, firms will enter or exit a perfectly competitive market based on whether the market price is above or below the minimum point of the long-run average cost curve. If the market price is above the minimum point of the long-run average cost curve, new firms will be attracted to enter the market, as they can earn economic profits. Conversely, if the market price falls below the minimum point of the long-run average cost curve, firms will exit the market, as they can no longer cover their costs. This long-run adjustment process continues until the market price is equal to the minimum point of the long-run average cost curve, where firms are earning just normal profits.

Related terms

Total Revenue: The total amount of money a firm receives from selling its products or services.

Demand Curve: The relationship between the price of a good or service and the quantity demanded of that good or service.

Profit Maximization: The process of a firm determining the output level that will generate the highest possible profit.