What is marginal revenue? How does the elasticity of demand affect marginal revenue?

Marginal revenue is the additional revenue that a firm earns when it sells one more unit of its product. In other words, it is the change in total revenue divided by the change in quantity sold. Mathematically, it can be expressed as: \( MR = \Delta TR / \Delta Q \) Where MR stands for marginal revenue, ΔTR stands for the change in total revenue, and ΔQ stands for the change in quantity sold.

In order to understand the effect of elasticity of demand on marginal revenue, we should first understand the relationship between price and revenue. Total revenue (TR) can be represented as: \( TR = P \times Q \) Where P is the price of the product and Q is the quantity sold.

Elasticity of demand is a measure of how sensitive the quantity demanded of a product or service is to a change in its price. It is calculated as: \( E = \dfrac{\% \Delta Q}{\% \Delta P} \) Where E is the elasticity of demand, %ΔQ is the percentage change in quantity demanded, and %ΔP is the percentage change in price.

Now, we can analyze the effect of elasticity of demand on marginal revenue. There are three main cases to consider: 1. Elastic Demand: When the elasticity of demand is greater than 1, an increase in price will result in a decrease in total revenue. This is because the percentage decrease in quantity demanded is larger than the percentage increase in price. In this case, the marginal revenue will be positive, encouraging the firm to lower its price to increase total revenue. 2. Inelastic Demand: When the elasticity of demand is less than 1, an increase in price will result in an increase in total revenue. This is because the percentage decrease in quantity demanded is smaller than the percentage increase in price. In this case, the marginal revenue will also be positive, encouraging the firm to raise its price to increase total revenue. 3. Unitary Elastic Demand: When the elasticity of demand is equal to 1, a change in price will not affect total revenue. In this case, the marginal revenue will be zero, and changing the price will not make any difference to total revenue. In conclusion, the elasticity of demand plays a crucial role in determining the marginal revenue. A firm must understand its product's demand elasticity to make informed decisions about pricing to optimize its total revenue.