Understanding the Concept of AR and MR in Perfect Competition
Have you ever wondered why average revenue (AR) is equal to marginal revenue (MR) in a perfectly competitive market? This article delves into the intricacies of this relationship, offering a comprehensive understanding of how these two key concepts are interconnected in a perfectly competitive environment.
What is Average Revenue (AR)?
Average revenue (AR) is the total revenue generated by a firm divided by the quantity of goods or services sold. In simpler terms, it represents the price at which each unit of output is sold. Mathematically, AR can be expressed as:
| AR | = | Total Revenue | / | Quantity Sold |
|---|
For example, if a firm sells 100 units of a product at $10 each, the AR would be $10 (Total Revenue of $1000 divided by 100 units sold).
What is Marginal Revenue (MR)?
Marginal revenue (MR) is the additional revenue generated by selling one more unit of a product. It is calculated by taking the difference between the total revenue from selling the current quantity and the total revenue from selling one less unit. Mathematically, MR can be expressed as:
| MR | = | Total Revenue at Quantity Q | – | Total Revenue at Quantity Q-1 |
|---|
Continuing with the previous example, if the firm sells 101 units at $10 each, the MR would be $10 (Total Revenue of $1010 at 101 units minus Total Revenue of $1000 at 100 units).
The Relationship Between AR and MR in Perfect Competition
In a perfectly competitive market, the price is determined by the market forces of supply and demand. Since all firms in the market are price takers, they must accept the market price for their product. This means that the AR for each firm is equal to the market price.
As a result, in a perfectly competitive market, AR is equal to MR. This is because the firm can sell one more unit of the product at the same market price, which means that the additional revenue generated from selling one more unit (MR) is equal to the price at which the firm sells each unit (AR).
Here’s a table to illustrate the relationship between AR and MR in a perfectly competitive market:
| Quantity Sold | Price | Total Revenue | AR | MR |
|---|---|---|---|---|
| 1 | $10 | $10 | $10 | $10 |
| 2 | $10 | $20 | $10 | $10 |
| 3 | $10 | $30 | $10 | $10 |
| 4 | $10 | $40 | $10 | $10 |
As you can see from the table, the AR and MR are both equal to $10, which is the market price in this perfectly competitive market.
Why is AR Equal to MR in Perfect Competition?
The reason why AR is equal to MR in a perfectly competitive market is due to the nature of the market itself. In a perfectly competitive market, there are many buyers and sellers, and no single firm has the power to influence the market price. This means that each firm must accept the market price and sell its product at that price.
Since the firm is a price taker, it can sell any quantity of the product at the market price
