Revenue, Marginal

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Revenue, Marginal

Marginal revenue is a concept introduced into economics by neoclassical economists, especially Alfred Marshall in his Principles of Economics (1890). It became a central concept in discussion of market structure with the publication of Joan Robinson’s The Economics of Imperfect Competition and Edward Chamberlin’s The Theory of Monopolistic Competition, both published in 1933. Since then it has been taught in all courses in microeconomics as part of the theory of the firm.

Marginal revenue refers to the change in total revenue arising from a change in output, where the change in output can denote a rise or fall and is usually thought of as a one-unit change. More formally,

where MR denotes marginal revenue, TR denotes total revenue, and Q the level of output. Δ is the symbol to denote “a change in.”

When used in terms of market structure, marginal revenue is related to the demand curve. The demand curve is also the average revenue curve, because it denotes the price people are willing to pay for each particular quantity. In perfect competition the demand curve is horizontal at a particular price, whereas for the typical demand curve, it is downward sloping, indicating that the quantity rises when the price falls. The relationship between marginal revenue and demand is obtained by considering the change in total revenue (ΔTR ). Because total revenue is price times quantity, then TR = P.Q and ΔTR = P. ΔQ + Q. ΔP. Hence, marginal revenue can be expressed as

Under perfect competition, the price does not change whatever the level of output, so ΔP /ΔQ = 0 and hence marginal revenue is equal to price, which in turn is equal to average revenue. In market structures other than perfect competition, the demand curve is downward sloping, in which case ΔP /ΔQ < 0, and so marginal revenue is less than price and the marginal revenue curve lies below the average revenue curve—the curve that denotes the price for any level of output.

The concept of marginal revenue is useful when it is combined with other marginal concepts, especially marginal cost, which refers to the change in total cost when output changes. More specifically, because profit is the difference between total revenue and total cost, then if marginal revenue exceeds marginal cost, profit must be increasing. Profits are falling when the reverse inequality holds. This means maximum profits can be identified when marginal revenue is equal to marginal cost. In the case of perfect competition, this also means that at the profit-maximizing output level, price is equal to marginal cost. However, under imperfect competition, monopolistic competition, and other market structures such as oligopoly, at the profit-maximizing output level, marginal revenue is below average revenue, which means price is above marginal cost (which is equal to marginal revenue). Both these results have social implications.

If price is equal to marginal cost (equal to marginal revenue), then society is paying at the margin just what it costs society to produce that final extra unit. This is the condition that holds under perfect competition. In contrast, in market structures where the demand curve is downward sloping, price is above marginal cost (which is equal to marginal revenue) at the profit-maximizing output level. Socially, this means that society is paying at the margin more than it is costing society to produce that last unit. In the case of monopoly, this leads to monopoly profits. This is not the case under monopolistic competition, where in the long run such profits can be eliminated as firms enter the industry. What can be observed from this analysis therefore is that it is the combination of marginal concepts that is important, and marginal revenue is just one of these.

Although marginal revenue, along with other marginal concepts, is taught in most courses in microeconomics, the concept is limited. The market structures referred to above in which the concept of marginal revenue played such an important part applies only to a single product firm. In fact almost all neoclassical analysis applies to single-product firms, which are abstract entities: not only do the firms produce only one product, but there is no internal organization. It would be difficult to apply the concept of marginal revenue to a modern multiproduct multinational company. Even so, as a logical concept it can eliminate muddled thinking.

SEE ALSO Average and Marginal Cost; Competition; Competition, Imperfect; Competition, Monopolistic; Competition, Perfect; Economics, Neoclassical; Economics, Neo-Ricardian; Marginalism; Maximization; Profits; Revenue; Revenue, Average