Understanding AR and MR in Perfect Competition
Have you ever wondered why average revenue (AR) and marginal revenue (MR) are equal under perfect competition? This article delves into the intricacies of this relationship, offering a comprehensive understanding of why this principle holds true in a perfectly competitive market.
What is Perfect Competition?
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 buyer or seller has the power to influence the market price. This ensures that all firms are price takers, meaning they must accept the market price as given.
What is Average Revenue (AR)?
Average revenue (AR) is the total revenue generated by a firm divided by the quantity of goods sold. In other words, it is the revenue per unit of output. In a perfectly competitive market, AR is equal to the market price, as all firms are price takers. This can be represented by the equation: AR = P, where P is the market price.
What is Marginal Revenue (MR)?
Marginal revenue (MR) is the additional revenue generated by selling one more unit of a good. In a perfectly competitive market, MR is also equal to the market price, as the firm can sell any additional unit at the market price without affecting the price. This can be represented by the equation: MR = P.
Why are AR and MR Equal in Perfect Competition?
The equality of AR and MR in perfect competition can be attributed to several factors:
1. Price Takers
In a perfectly competitive market, firms are price takers, meaning they have no control over the market price. As a result, the price remains constant regardless of the quantity sold. Since AR is the price per unit, and MR is the additional revenue from selling one more unit, both are equal to the market price.
2. Homogeneous Products
Perfectly competitive markets are characterized by homogeneous products, meaning that the goods sold by different firms are identical. This ensures that consumers perceive no difference between the products of different sellers, leading to a constant price for all units sold. Consequently, AR and MR remain equal.
3. Perfect Information
Perfect information in a perfectly competitive market ensures that buyers and sellers are fully aware of the market price and the quantity of goods available. This transparency prevents any firm from manipulating the price, as they would be easily identified and boycotted by consumers. As a result, AR and MR remain equal.
4. Free Entry and Exit
Free entry and exit in a perfectly competitive market ensure that new firms can enter the market and existing firms can exit without any barriers. This prevents any single firm from gaining excessive market power, as new competitors can always enter and compete for market share. This competition keeps the price constant, and thus AR and MR remain equal.
Table: Comparison of AR and MR in Perfect Competition
| Quantity Sold | Market Price (P) | Average Revenue (AR) | Marginal Revenue (MR) |
|---|---|---|---|
| 1 | $10 | $10 | $10 |
| 2 | $10 | $10 | $10 |
| 3 | $10 | $10 | $10 |
| 4 | $10 | $10 | $10 |
In conclusion, the equality of AR and MR in perfect competition is a result of various factors, including being price takers, homogeneous products, perfect information, and free entry and exit. Understanding this relationship is crucial for analyzing the behavior of firms in a perfectly competitive market.
