Question

Explain the relationship between marginal revenue and the own price elasticity of demand.

Short answer

The marginal revenue increases with the decrease in own price elasticity of demand.

Step-by-step solution

Definition

Marginal revenue:In economics, marginal revenue signifies the change in revenue the firm experiences due to the change in the quantity sold in the market.

Own price elasticity:The demand curve's response against the commodity's price change indicates its elasticity. Own price determines the change in demand for a particular good whose price has changed.

Relationship between marginal revenue and own price elasticity of demand:

The marginal revenue is inversely proportional to the elasticity of demand. An increase in price elasticity will signify a rigorous fall in the demand if the price increases for a commodity, thus reducing the firm's revenue comparatively more than the increase in the price.

On the other hand, a decrease in the elasticity of demand signifies an inelastic demand for the commodity. Such indicates that with the increase in the commodity price, the demand would not change rigorously, thus increasing the revenue for the firm.

For example, if a rice producer that gains a revenue of $2.3 billion each year increases selling price by 28%. However, he tends to experience an increase in his revenue, even though the price increase tends to decrease the demand for the commodity, indicating that demand has not reduced rigorously as he expected it to be. Hence, the price increase has increased his revenue as well.

Thus, one can understand that marginal revenue tends to have an inverse relation to the own price elasticity.