Total, Average, and Marginal Revenue

To maximize profit, a firm needs to consider both its revenue and its costs. Consider the revenue side. Farmer Fred has a small farm producing wheat and has no control over the market price, which is $7 per bushel, no matter how much he produces. __Marginal revenue__ is the additional revenue a firm earns from selling one more unit. What is Fred's marginal revenue from selling one more bushel of wheat?
No, marginal revenue doesn't change when he produces more.
No, he won't get more than the market price.
That's right. Since Fred is a small farmer with no control over the price, he is considered a perfect competitor. This means he can sell as much as he wants and the price won't change. Therefore, the marginal revenue, or addition to revenue from selling one more unit, is equal to the price.
As Fred produces more, what happens to his total revenue?
Exactly! total revenue is price times quantity, and in this example, the price stays the same as the quantity rises. For a perfect competitor like Fred, total revenue _always_ rises as production increases.
No, remember that total revenue is price times quantity, and in this example, the price stays the same as the quantity rises.
No, total revenue will change as more is produced.
__Average revenue__ is total revenue divided by the total quantity sold. For a perfect competitor like Fred, how is average revenue related to the price?
No. When Fred produces and sells another bushel, total revenue rises by the price of that bushel, which is constant.
Yes!
Suppose that the current price of Bran Bites is $4 per box, and Major Mills wants to sell more boxes this month than last month. What would the new price have to be?
That's right, the only way an imperfect competitor can sell more is to reduce the price. Of course, reducing the price means lowering the price on _all_ boxes sold.
No, that would be the case for a perfectly competitive firm like Fred, but not an _imperfectly_ competitive firm like Major Mills.
No, a higher price would allow them to sell _less_, not more.
Remember that marginal revenue is the additional revenue a firm earns from selling one more unit. So with the price cut, is Major Mills' marginal revenue from selling another box of cereal greater or less than the price?
No. Major Mills earns more total revenue from selling another box of cereal, but the amount of that additional revenue is hurt by the fact that they have to lower the price on all boxes sold. Marginal revenue is therefore less than the price.
Yes!
Here's a numerical example. Suppose Major Mills can sell one million boxes of Bran Bites at a price of $4, but to sell 1.1 million boxes, their price must drop to $3.75. Total revenue would be $4 million at a price of $4 and $4.125 million at a price of $3.75.
So selling 100,000 more boxes causes total revenue to rise by $125,000. What is the marginal revenue from selling those extra 100,000 boxes?
No.
Exactly!
To sum up: [[summary]]
If Fred sells 10 bushels at $7, total revenue is 10 bushels × $7 = $70. Average revenue is total revenue divided by quantity, which is $70/10 bushels = $7, exactly the same as the price.
Now consider Major Mills, a large breakfast cereal producer, which buys wheat from farmers like Fred, to turn into cereals like Bran Bites. Since there are only a few breakfast cereal manufacturers, this industry would be considered _imperfectly_ competitive: each firm has a large enough share of the market that it has some power over the market price, and therefore faces a downward-sloping demand curve. This implies that the only way to sell more is to reduce the price.
Marginal revenue is the change in total revenue ($125,000) divided by the change in quantity (100,000 boxes), which is $1.25. Notice that marginal revenue is less than the price. Here the price of one more box of cereal is $3.75, but the extra revenue that last box of cereal brings into the firm is only $1.25. The fact that marginal revenue is always less than the price for imperfect competitors has important implications for their output decisions.
More than $7
$7
Less than $7
Total revenue falls
Total revenue rises
Total revenue stays the same
Average revenue equals the price
Average revenue is greater than the price
Less than $4
$4
Greater than $4
Greater
Less
$1.25
$125,000
$4.125 million
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