Marginal Revenue, Average Revenue, and Profit Maximization in Perfect Competition
TITLE
Explain the relationship between marginal revenue and average revenue and their role in determining the output and profit of a profit maximising firm in a perfectly competitive market.
ESSAY
Title: Understanding the Relationship between Marginal Revenue and Average Revenue in Perfectly Competitive Markets for Profit Maximization
Introduction
In a perfectly competitive market, firms are price takers, meaning they must accept the market price for their goods or services. Understanding the concepts of marginal revenue (MR) and average revenue (AR) is crucial in determining the optimal output level for profit maximization in such markets.
Definition of Average Revenue (AR) and Marginal Revenue (MR)
Average Revenue (AR): AR is the revenue generated per unit of output sold. It is calculated by dividing total revenue by the quantity of output sold. In a perfectly competitive market, AR is equal to the market price.
Marginal Revenue (MR): MR is the additional revenue earned from selling one additional unit of output. In a perfectly competitive market, MR is equal to the market price.
Nature of AR and MR in Perfectly Competitive Markets
In perfectly competitive markets, firms face a horizontal demand curve at the prevailing market price. This implies that AR remains constant at the market price, resulting in a flat AR curve. As a result, AR equals both the market price and MR in such markets.
Marginal Cost (MC) Equality to MR for Profit Maximizing Output
In order to maximize profit, a firm operating in a perfectly competitive market will produce the quantity of output where marginal cost (MC) equals marginal revenue (MR). This is because in the short run, profits are maximized by producing the level of output where MR equals MC.
Difference between Average Cost (AC) and Average Revenue (AR) to Determine Profits
To determine profits, a firm must compare its average cost (AC) with its average revenue (AR). If AR exceeds AC at the profitš„maximizing output level where MR = MC, the firm is making a profit. Conversely, if AC exceeds AR, the firm is incurring losses.
Short Run and Long Run Changes
In the short run, firms may experience both profits and losses as market conditions fluctuate. However, in the long run, due to perfect competition, firms are unable to sustain longš„term economic profits. New firms enter the market in response to profits, increasing market supply and driving down prices until equilibrium is restored.
Conclusion
In conclusion, understanding the relationship between marginal revenue, average revenue, and costs is essential for a profitš„maximizing firm in a perfectly competitive market. By producing at the output level where MR equals MC, firms can determine the optimal level of output to maximize profits in the short run. However, in the long run, competitive forces drive profits to normal levels in a perfectly competitive market.
SUBJECT
ECONOMICS
PAPER
A level and AS level
NOTES
Relationship Between Marginal Revenue and Average Revenue in Perfectly Competitive Markets
Marginal revenue (MR) and average revenue (AR) are essential concepts that play a crucial role in determining the output and profit of a profitš„maximizing firm in a perfectly competitive market.
Average revenue (AR) refers to the revenue generated per unit of output sold. It is calculated by dividing total revenue by the quantity of output sold. On the other hand, marginal revenue (MR) is the extra revenue earned by selling one additional unit of output.
In a perfectly competitive market, firms are price takers, meaning they cannot influence the price at which they sell their goods. As a result, average revenue is equal to the price of the product and remains constant regardless of the quantity of output sold. Marginal revenue, however, decreases as the quantity of output increases, reflecting the fact that the firm must lower its price to sell additional units.
For a profitš„maximizing firm in perfect competition, the key decision criterion is to produce the level of output where marginal cost (MC) is equal to marginal revenue (MR). This is because producing beyond this point would mean that the cost of producing an additional unit exceeds the revenue generated, leading to reduced profits.
The difference between average cost (AC) and average revenue (AR) is used to determine the level of profits. If average revenue exceeds average cost, the firm is making a profit. Conversely, if average cost is greater than average revenue, the firm is experiencing losses.
In the short run, firms may continue to operate even if they are making losses as long as they can cover their variable costs. However, in the long run, firms must make a profit to stay in business, leading to market adjustments such as entry or exit of firms to achieve longš„run equilibrium.
In conclusion, understanding the relationship between marginal revenue, average revenue, marginal cost, and average cost is crucial for a profitš„maximizing firm in a perfectly competitive market. By analyzing these relationships, firms can determine the optimal level of output and maximize their profits under competitive market conditions.