Question

Why is the MR curve below the AR curve under imperfect competition?

Why does the MR curve lie below the AR curve under imperfect competition?

What is the relationship between AR and MR of a firm under imperfect competition?

Answer 1

The Marginal Revenue (MR) curve lies below the Average Revenue (AR) curve under imperfect competition because when a firm wants to sell an additional unit of output, it must lower the price not only for that extra unit but also for all previous units sold. This price reduction on all units causes the additional revenue gained from selling one more unit (the MR) to be less than the price at which that unit is sold (the AR or average revenue).

• Under imperfect competition, the firm faces a downward-sloping demand curve, so average revenue (price) decreases as quantity sold increases.
• To sell an additional unit, the firm must reduce the price on all units, which means marginal revenue is less than average revenue.
• Hence, the MR curve lies below the AR curve at all output levels.
• Additionally, when the AR curve is a straight downward sloping line, the MR curve falls twice as fast.
• In contrast, under perfect competition, the price remains constant as output increases, so MR equals AR, and the two curves coincide.

In summary, the MR curve is below the AR curve under imperfect competition because selling an additional unit requires lowering the price on all units, making the marginal revenue less than the average revenue or price received.

This explanation is illustrated by the fact that marginal revenue equals the price of the additional unit sold minus the revenue lost from having to reduce the price on all previous units sold. Therefore, MR < AR whenever the AR curve slopes downward.