Why is the marginal revenue for a monopoly lower than its price?

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mkoren eNotes educator| Certified Educator

When a company has a monopoly, you might think that the company can charge whatever price it wants for the products they sell. However, that is not the case. Many monopolies are regulated and need permission to increase prices. An example would be the electric company. The electric company needs government approval to raise prices.

In a monopolistic situation, the price is determined by equalling marginal revenue to marginal cost. Marginal revenue is the additional revenue received by selling one additional unit of a product. Marginal cost is the additional cost of producing one additional unit of the product. When marginal revenue equals marginal cost, a company doesn’t lose money by producing too much or too little of a product. In a monopolistic situation, the price of the product will impact the demand for the product. As a result, the demand curve slopes downward. In order to sell more of a product, the marginal revenue curve will drop as each additional item is sold.

If you found you could sell ten shirts at $10.00 each, the total revenue will be $100.00. If you wanted to sell one more shirt, for a total of eleven, you would have to lower the price to $9.75 to make that sale. However, you have to sell all of shirts at $9.75. Thus, the total revenue is $107.25. In order to sell the eleventh shirt, the marginal revenue is $7.25. While the demand curve shows the shirt could be sold for $9.75, the marginal revenue curve shows the revenue at $7.25. As a result, the marginal revenue curve is lower than the demand curve because the drop in price applies to all shirts that are sold.

pohnpei397 eNotes educator| Certified Educator

In a monopoly, the marginal revenue is lower than the price because the demand curve is downward sloping.  When prices go down, more units of the product are bought.

Because of this, marginal revenue will not always equal price (and will never equal price in the textbooks).

Think about this example:

You charge $150 and sell 0.  So you drop your price.  Then you charge $138 and sell 1.  You drop the price even lower -- to $125 and you sell 2.  Your marginal revenue for the second unit sold was $112 even though the price was $125.

So, the reason is because, unlike in perfect competition, the demand curve is downward sloping.

krishna-agrawala | Student

The question assumes that marginal revenue is always less than the unit price. This is not true. As a matter of fact it is nor right to even compare the two as the two refer to quite different things. It is like comparing speed with distance.

Please note that price is specified as money or dollars per unit of product, just as speed is expressed as distance per unit of time. In comparison revenue, including marginal revenue, is measured in terms of just money or dollars, just as distance is specified in some unit of distance such as meters.

Further, please note that for the same change in price, the marginal revenue can be positive, negative or zero depending upon price elasticity of demand. The marginal revenue increases with increasing elasticity of demand. With elasticity of less than 1 the marginal revenue is negative, and with elasticity more than 1 the marginal revenue is positive, and keeps on increasing with increasing elasticity. When elasticity is zero, the marginal revenue is also zero.