Understanding the Basics
When delving into the relationship between Average Revenue (AR) and Marginal Revenue (MR) under perfect competition, it’s crucial to grasp the fundamental concepts of both. Average Revenue refers to the total revenue generated by a firm divided by the quantity of goods sold. Marginal Revenue, on the other hand, is the additional revenue a firm earns from selling one more unit of a good.
AR in Perfect Competition
In a perfectly competitive market, the Average Revenue is constant and equal to the price of the good. This is because, in such a market, firms are price takers, meaning they have no control over the price and must accept the market price. Therefore, the AR curve is a horizontal line at the market price.
MR in Perfect Competition
Under perfect competition, the Marginal Revenue is also constant and equal to the price of the good. This is because, in a perfectly competitive market, the firm can sell as much as it wants at the market price, so selling one more unit does not affect the price. Hence, the MR curve is also a horizontal line at the market price.
Relationship between AR and MR
The relationship between AR and MR in perfect competition is straightforward. Since both AR and MR are constant and equal to the market price, they are the same. This means that the firm’s revenue from selling one more unit (MR) is exactly the same as the average revenue per unit (AR). The table below illustrates this relationship:
| Quantity Sold | Price | Average Revenue (AR) | Marginal Revenue (MR) |
|---|---|---|---|
| 1 | $10 | $10 | $10 |
| 2 | $10 | $10 | $10 |
| 3 | $10 | $10 | $10 |
| 4 | $10 | $10 | $10 |
Implications for Firms
The fact that AR and MR are equal in perfect competition has important implications for firms. Since the firm’s revenue from selling one more unit is the same as the average revenue per unit, the firm should continue to produce as long as the marginal cost is less than or equal to the market price. This ensures that the firm maximizes its profit.
Conclusion
In conclusion, the relationship between Average Revenue and Marginal Revenue under perfect competition is a fundamental concept that helps firms make informed decisions about production and pricing. By understanding this relationship, firms can ensure they maximize their profits in a perfectly competitive market.
