Question

Check all that apply. In a perfectly competitive market, \(\mathrm{MR}=\left[\mathrm{LO}_{13.2}\right]\) a. Price b. Average revenue c. Total revenue d. \(\frac{\Delta \text { in total revenue }}{\Delta \text { in quantity }}\)

Short answer

a, b, and d apply in a perfectly competitive market.

Step-by-step solution

Understanding Perfect Competition

In a perfectly competitive market, firms are price takers. This means that the price is determined by the market and is constant for each firm, regardless of the quantity they sell.

Define Marginal Revenue (MR)

Marginal Revenue is the additional revenue that a firm receives from selling one more unit of a good or service. Mathematically, it is defined as \(MR = \frac{\Delta TR}{\Delta Q}\), where \(\Delta TR\) is the change in total revenue and \(\Delta Q\) is the change in quantity.

Relation between MR and Price

In perfect competition, each additional unit of output sold will fetch the same price. Thus, marginal revenue, is equal to the price of the good. Hence, \(MR = P\).

Relation between MR and Average Revenue (AR)

Average Revenue (AR) is the revenue a firm receives per unit sold, which is the price in perfect competition. Since \(AR = \frac{TR}{Q} = P\) and \(MR = P\), it follows that \(MR = AR\) in a perfectly competitive market.

Analyze the options

In a perfectly competitive market, \(MR\) is equal to Price and Average Revenue due to the market being a price taker. Also, since \(\frac{\Delta TR}{\Delta Q} = MR\), this is correct too. However, \(MR\) is not directly equal to Total Revenue in any market condition.

Key concepts

Marginal Revenue

Marginal Revenue (MR) is a fundamental concept especially relevant in understanding how firms determine the quantity of a product to produce. In simple terms, marginal revenue is the extra revenue a company earns from selling one additional unit of a product. For students learning economics, it's important to know that MR is calculated using the formula: \(MR = \frac{\Delta TR}{\Delta Q}\), where \(\Delta TR\) denotes the change in total revenue and \(\Delta Q\) represents the change in quantity.

In a perfectly competitive market, a firm's MR is remarkably straightforward because it is identical to the price at which the product is sold. This implies that for every extra unit sold, the firm earns an additional revenue equal to the selling price. This relationship holds because firms in such markets are price takers, meaning they have no power to influence market prices. This aspect makes decision-making for firms much simpler in terms of production as they aim to maximize profits.

Average Revenue

Average Revenue (AR) is another key concept closely related to both price and marginal revenue. AR represents the average earnings a company retains from each unit sold, calculated as the total revenue divided by the number of units sold: \(AR = \frac{TR}{Q}\).

In a perfectly competitive market, because the price remains constant regardless of how many units a firm sells, the average revenue is equal to the market price. Therefore, \(AR = P\) in such markets. This means for every unit of product sold, the firm's revenue per unit (average revenue) equals the price, just like marginal revenue. This equality of AR and MR simplifies the revenue analysis significantly as it allows firms to predict their earnings accurately based on the selling price.

Price Takers

The concept of price takers is crucial for understanding the dynamics of a perfectly competitive market. Firms categorized as price takers do not have the power to set the prices of their products; rather, they accept the market-determined price as given. This status occurs in markets characterized by many sellers and buyers, homogeneous products, and free entry and exit, which collectively ensure no single firm can influence market prices.

For instance, if a farmer grows wheat in a region with numerous other wheat farmers, they must sell their wheat at the going market rate. If they attempt to charge more, buyers will simply purchase from another farmer who offers the standard market price. This situation leads firms to focus primarily on controlling costs and optimizing production as their strategies for competitiveness.

Total Revenue

Total Revenue (TR) is the overall income a firm receives from selling its goods or services. It is a pivotal measure for businesses, guiding them in understanding how profitable their operations are. Total revenue is calculated simply by multiplying the price (P) by the quantity of goods sold (Q): \(TR = P \times Q\).

In perfectly competitive markets, although price is a constant and given factor, firms must decide on the optimal quantity to produce to maximize their total revenue and subsequent profit. It's important to realize that while marginal revenue and average revenue relate closely to the concept of price, total revenue gives a broader picture of the firm's financial performance. By analyzing changes in total revenue with respect to different quantities sold, firms can gather insights on the economic viability of scaling their production levels.