The relation between marginal revenue and the quantity of output produced depends on market structure. For a perfectly competitive firm, marginal revenue is equal to price and average revenue, all three of which are constant. For a monopoly, monopolistically competitive, or oligopoly firm, marginal revenue is less than average revenue and price, all three of which decrease with larger quantities of output. The constant or decreasing nature of marginal revenue is a prime indication of the market control of a firm.

Marginal revenue can be represented in a table or as a curve. For a perfectly competitive firm, the marginal revenue curve is a horizontal, or perfectly elastic, line. For a monopoly, oligopoly, or monopolistically competitive firm, the marginal revenue curve is negatively sloped.

The marginal revenue received by a firm is the change in total revenue divided by the change in quantity, often expressed as this simple equation:

marginal revenue

=

change in total revenue change quantity

Perfect Competition

Marginal Revenue, Zucchini Style

The table to the right summarizes the marginal revenue received by a hypothetical firm, Phil the zucchini grower, for selling zucchinis in a perfectly competitive zucchini market. The first column is the quantity of zucchinis sold, ranging from 0 to 10 pounds. The second column is then the price Phil receives for selling his zucchinis, which is $4 per pound. The third column is the total revenue Phil receives for producing and selling alternative quantities of zucchinis.

Marginal revenue in the forth column is found by dividing the change in total revenue (from the third column) by the change in quantity (from the first column). For example, when Phil increases production and sales from 4 pounds of zucchinis to 5 pounds, his total revenue increases from $16 to $20, an increase of $4. As such, the marginal revenue of producing the fifth pound of zucchinis is $4 (= $4/1). Each value in the fourth column is calculated in the same way.

The obvious point is that marginal revenue is equal to $4 for every extra pound of zucchinis sold. This results because price is constant at $4 for every pound of zucchinis sold. For every extra pound of zucchinis sold by Phil, he receives an extra $4, which is the going market price. Marginal revenue is equal to price for a perfectly competitive firm.

Marginal Revenue Curve, Zucchini Style

Marginal revenue is commonly represented by a marginal revenue curve, such as the one labeled MR and displayed in the exhibit to the right. This particular marginal revenue curve is that for zucchini sales by Phil the zucchini grower, a presumed perfectly competitive firm.

The vertical axis measures marginal revenue and the horizontal axis measures the quantity of output (pounds of zucchinis). Although quantity on this particular graph stops at 10 pounds of zucchinis, the nature of perfect competition indicates it could easily go higher.

This curve indicates that if Phil sells the first pound of zucchinis (an increase in production from 0 to 1), then his extra revenue is $4. However, if he sells his tenth pound (an increase in production from 9 to 10), then he also receives $4 of extra revenue. Should he sell his hundredth pound (an increase in production from 99 to 100), then he moves well beyond the graph, but his marginal revenue remains at $4.

Because Phil is a perfectly competitive firm, his marginal revenue curve is also his demand curve and his average revenue curve. All three curves coincide for perfect competition.

Monopoly, Oligopoly, and Monopolistic Competition

Marginal Revenue, Medicine Style

The table to the right summarizes the marginal revenue received by another hypothetical firm, Feet-First Pharmaceutical. This firm owns the patent to Amblathan-Plus, the only cure for the deadly, but hypothetical, foot ailment known as amblathanitis. As the only producer of Amblathan-Plus, Feet-First Pharmaceutical is a monopoly with extensive market control, facing a negatively-sloped demand curve. To sell a larger quantity of Amblathan-Plus, Feet-First Pharmaceutical must lower the price.

The first column is the quantity of Amblathan-Plus sold, ranging from 0 to 12 ounces. The second column is the price Feet-First Pharmaceutical receives for selling this medicine, which ranges from $4.50 to $10.50 per ounce. The third column is the total revenue Feet-First receives for producing and selling this medicine.

Marginal revenue in the forth column is found by dividing the change in total revenue (from the third column) by the change in quantity (from the first column). For example, when Feet-First Pharmaceutical increases production and sales from 4 ounces of Amblathan-Plus to 5 ounces, its total revenue increases from $34 to $40, an increase of $6. As such, the marginal revenue of producing the fifth ounce of Amblathan-Plus is $6 (= $6/1). Each value in the fourth column is calculated in the same way.

One obvious point is that marginal revenue decreases with the quantity of medicine produced. A second point is that marginal revenue is less than the price of Amblathan-Plus for each quantity sold. The price of the fifth ounce of Amblathan-Plus is $8, but the marginal revenue generated by the fifth ounce is only $6. Marginal revenue is less than price. And because price is average revenue, marginal revenue is also less than average revenue.

Marginal Revenue Curve, Medicine Style

The marginal revenue curve for firms with market control looks a little different than that for perfect competition. The marginal revenue curve (MR) for Feet-First Pharmaceutical is displayed in the exhibit to the right. Key to this curve is that Feet-First Pharmaceutical is a monopoly provider of Amblathan-Plus and thus faces a negatively-sloped demand curve. Larger quantities of output are only possible with lower prices.

The vertical axis measures marginal revenue and the horizontal axis measures the quantity of output (ounces of medicine). Although quantity on this particular graph stops at 12 ounces of medicine, it could go higher.

This exhibit displays both the marginal revenue curve (MR) and the average revenue curve (AR), which is also the demand curve. Both are negatively sloped, but the marginal revenue curve lies below the average revenue curve, which means that marginal revenue is less than average revenue (and price) for any given quantity.