Understanding the AR and MR Curves Under Monopoly
Monopolies, by their very nature, have the power to control the market and dictate prices. This unique position allows them to analyze and understand their demand and revenue functions in great detail. Two of the most crucial tools in this analysis are the Average Revenue (AR) and Marginal Revenue (MR) curves. In this article, we will delve into the intricacies of these curves under a monopoly scenario, providing you with a comprehensive understanding of how they work and their implications for pricing and production decisions.
What is Average Revenue (AR)?
AR, also known as price, is the total revenue generated by a firm divided by the quantity of goods sold. In a monopoly, the AR curve is downward-sloping, indicating that as the quantity of goods sold increases, the price at which the goods are sold decreases. This is because a monopolist faces the entire market demand curve, and as they sell more, they must lower the price to attract additional consumers.
Here’s a simple table to illustrate the relationship between quantity sold and AR in a monopoly scenario:
| Quantity Sold | Price | AR |
|---|---|---|
| 1 | $10 | $10 |
| 2 | $9 | $9 |
| 3 | $8 | $8 |
| 4 | $7 | $7 |
| 5 | $6 | $6 |
What is Marginal Revenue (MR)?
MR is the additional revenue a firm earns from selling one more unit of a good. In a monopoly, the MR curve is also downward-sloping but lies below the AR curve. This is because, as a monopolist sells more, the price at which they can sell additional units decreases, leading to a lower MR. The MR curve is typically steeper than the AR curve, indicating that the decrease in price for additional units is more significant than the decrease in price for the initial units sold.
Let’s take a look at the MR curve in relation to the AR curve using the same table as before:
| Quantity Sold | Price | AR | MR |
|---|---|---|---|
| 1 | $10 | $10 | $10 |
| 2 | $9 | $9 | $8 |
| 3 | $8 | $8 | $7 |
| 4 | $7 | $7 | $6 |
| 5 | $6 | $6 | $5 |
Implications for Pricing and Production Decisions
Understanding the AR and MR curves is crucial for a monopolist when making pricing and production decisions. Here are some key implications:
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Maximizing Profit: A monopolist will maximize profit by producing the quantity where MR equals MC (Marginal Cost). This is because, at this point, the additional revenue from selling one more unit is equal to the additional cost of producing that unit.
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Price Setting: The monopolist will set the price at the quantity where AR equals MR. This is because, at this point, the price is equal to the additional revenue from selling one more unit.
