Understanding the Basics
When discussing the relationship between total revenue (TR) and marginal revenue (MR) under perfect competition, it’s essential to first understand the concepts of each. Total revenue is the total income a firm earns from selling its goods or services. Marginal revenue, on the other hand, is the additional revenue a firm earns from selling one more unit of its product.
Perfect Competition: The Market Structure
Perfect competition is a market structure characterized by a large number of buyers and sellers, homogeneous products, perfect information, and free entry and exit. In such a market, no single firm has the power to influence the market price. Each firm is a price taker, meaning it must accept the market price as given.
Total Revenue and Marginal Revenue in Perfect Competition
In perfect competition, the relationship between TR and MR is straightforward. Since firms are price takers, the price of the product remains constant regardless of the quantity sold. This means that MR is equal to the price of the product. Therefore, the relationship between TR and MR can be expressed as follows:
| Quantity Sold | Price | Total Revenue | Marginal Revenue |
|---|---|---|---|
| 1 | $10 | $10 | $10 |
| 2 | $10 | $20 | $10 |
| 3 | $10 | $30 | $10 |
| 4 | $10 | $40 | $10 |
As you can see from the table, the price remains constant at $10, and the marginal revenue is also $10 for each additional unit sold. This relationship holds true for all quantities sold in perfect competition.
Why is MR Equal to Price in Perfect Competition?
The reason why MR is equal to price in perfect competition is that the firm can sell any quantity of the product at the market price. When a firm sells an additional unit, it does not have to lower the price for all units sold. Therefore, the additional revenue from selling one more unit is equal to the market price.
Implications of MR Equaling Price
The fact that MR equals price in perfect competition has several implications. One of the most significant is that firms in perfect competition can only earn normal profits in the long run. This is because, in the long run, firms can enter or exit the market, and if firms are earning above-normal profits, new firms will enter the market, increasing supply and driving down prices. Conversely, if firms are earning below-normal profits, some firms will exit the market, decreasing supply and driving up prices.
Conclusion
In conclusion, the relationship between total revenue and marginal revenue under perfect competition is straightforward. Since firms are price takers, MR is equal to the price of the product. This relationship has important implications for firms in perfect competition, including the ability to earn only normal profits in the long run. Understanding this relationship is crucial for firms operating in a perfectly competitive market.
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