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Chapter 13: Problem 3

With a downward-sloping demand curve, why is average revenue equal to price? Why is marginal revenue less than price?

Short Answer

Expert verified
In the downward-sloping demand curve, average revenue equals price because it is the price of each unit sold. However, the marginal revenue is less than the price because to sell an additional unit, the price must be lowered, which also reduces the price for all units, not just the extra one. Hence the loss on earlier units causes marginal revenue to be less than price.

Step by step solution

01

Understanding Average Revenue and Price

Average revenue refers to the average amount of money that a firm receives per unit of output sold. This is calculated by dividing the total revenue by the quantity of the product sold. In any market structure, the average revenue is always equal to the price of the product. Mathematically, \(Price = AR = \frac{TR}{Q}\) where TR is the Total Revenue and Q is the quantity of goods sold.
02

Recognizing Downward Sloping Demand Curve

A downward-sloping demand curve is a characteristic of monopolistic and oligopolistic market structures. It implies that in order to sell more units of output, the firm must lower the price of its product. This is because the additional units are sold at a lower price than the previous ones, reducing the total revenue gained per unit.
03

Understanding Marginal Revenue and Price

Marginal Revenue is the additional revenue that the firm gains from selling one more unit of its product. In a market with a downward-sloping demand curve, the marginal revenue is always less than the price. This is because the firm needs to lower the price to sell the extra unit, which leads to a loss of revenue on the previous units that could have sold at a higher price. Mathematically, \(MR < Price\), since as quantity sold increases, the price decreases.

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Most popular questions from this chapter

Why doesn't a monopolistically competitive firm produce where \(P=M C\), as a perfectly competitive firm does?

What are the differences between the long-run equilibrium of a perfectly competitive firm and the long-run equilibrium of a monopolistically competitive firm?

In \(1916,\) Ford Motor Company produced 500,000 Model T Fords, at a price of \(\$ 440\) each. The company made a profit of \(\$ 60\) million that year. Henry Ford told a newspaper reporter that he intended to reduce the price of the Model \(\mathrm{T}\) to \(\$ 360\), and he expected to sell 800,000 cars at that price. Ford said, "Less profit on each car, but more cars, more employment of labor, and in the end we get all the total profit we ought to make." a. Did Ford expect the total revenue he received from selling Model Ts to rise or fall following the price cut? b. Use the information given above to calculate the price elasticity of demand for Model Ts. Use the midpoint formula to make your calculation. (See Chapter 6 , page \(186,\) if you need a refresher on the midpoint formula.) c. What would the average total cost of producing 800,000 Model Ts have to be for Ford to make as much profit selling 800,000 Model Ts as it made selling 500,000 Model Ts? Is this smaller or larger than the average total cost of producing 500,000 Model Ts? d. Assume that Ford would make the same total profit when selling 800,000 cars as when selling 500,000 cars. Was Henry Ford correct in saying he would make less profit per car when selling 800,000 cars than when selling 500.000 cars?

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