Relationship among Total, Average and Marginal Revenues under Imperfect Competition
Alternatively, the loss of revenue of Rs. 1 on first unit can be deducted from the price at which the second unit is sold, to get its marginal revenue. This loss is due to the fall in price as a result of the sale of one additional unit.
Marginal revenue is, therefore, Rs. 9 – Rs. 1 = Rs. 8. Further, when price declines to Rs. 8, only 3 units are sold and TR increases to Rs. 24. The increase in TR by selling this unit is Rs. 6, which is the MR of the third unit.
Alternatively, MR of the third unit can be obtained by subtracting Rs. 2 (total loss of revenue on first two units) from Rs. 8 (the price of the third unit). Again, MR is the same, i.e. Rs. 6. In the same way, MR of the other units can be calculated. We, thus, observe that with the increase in sales, price falls and marginal revenue is less than the price (or AR). That is why, the MR curve lies below the AR curve and declines at a faster rate.
It is important to note that the falling MR curve bisects the distance on the X-axis between the point of origin and the point, where the AR curve touches the X-axis in two equal parts. But, this relationship will not hold true, if the AR curve is not a straight line that slopes downward.
It may be further observed that so long as the TR is increasing, MR is positive. MR is positive for the first five units. Thus, TR curve starting from the origin continues to increase upto five units. TR does not change between fifth and sixth unit.
When TR is unaffected by the increase in quantity, MR is equal to zero. TR is maximum corresponding to zero MR at the sixth unit. Beyond sixth unit, TR falls and MR becomes negative. MR of the seventh unit is – 2 and that of eighth unit are – 4. Thus, while AR is always positive. MR can be positive, zero or even negative.
The relationship among TR, AR and MR can be summarised as follows:
(i) Initially, TR (i.e., price x units of the commodity sold) increases at a diminishing rate with increase in the units of output, since more units of the commodity can only be sold at a lower price, such that MR is positive and is downward sloping.
(ii) When TR is maximum, MR becomes equal to zero.
(iii) MR becomes negative, when TR decreases with increase in the units of output.
(iv) MR falls with the fall in AR, but, the rate of decrease in MR is much higher than that in AR.
(v) MR may be positive, negative or zero, but AR is always positive (since negative price is absurd)
The above relationship holds true in case of all forms of imperfect competition that is, monopoly, duopoly, oligopoly, monopolistic competition, etc. Under imperfect competition, as a firm lowers the price, the quantity demanded goes up and average revenue curve slopes downward as a result.