What is the relation between market price and average revenue of a price-taking firm?

Exercises · Q5

Q. What is the relation between market price and average revenue of a price-taking firm?

Bihar BsebTextbookSubjective· 2mImportance★★★★★

14% · 5/37 Questions

🔒 Locked · start free trial →

You're viewing a preview — the full solution, concept, methods & PYQ mapping are locked.

Start your 14-day free trial to unlock the full solution →

Concept understanding — Marginal Revenue Constant

Marginal Revenue Constant: When Every Extra Unit Earns the Same

Think about a lemonade stand. On a hot day, you sell the first glass for ₹20. The second glass? Still ₹20. The third? ₹20 again. Every time you sell one more glass, your total revenue goes up by exactly ₹20. That ₹20 is your marginal revenue — and it stays the same no matter how many glasses you sell.

That is the simplest case of constant marginal revenue. But in economics, this situation is special, not automatic. Let's see why.

The Precise Meaning

Marginal Revenue (MR) is the change in total revenue when you sell one additional unit of output.

MR = \frac{\Delta TR}{\Delta Q}

Where:

$\Delta TR$ = change in total revenue
$\Delta Q$ = change in quantity sold (usually 1 unit)

When MR is constant, it means every extra unit you sell adds exactly the same amount to your total revenue. The number does not change as you sell more.

When Does MR Stay Constant?

This happens only when the firm can sell any quantity at the same price — that is, when the firm is a price taker. In perfect competition, the market sets the price, and the individual firm cannot influence it. So:

MR = P

The marginal revenue from selling one more unit is simply the market price. And since the price does not change with the firm's output, MR is constant.

Important

In perfect competition, $MR = AR = P$ at every level of output. The MR curve is a horizontal straight line at the market price.

Why It Matters

Constant MR changes how a firm thinks about profit. If MR is constant, the firm's total revenue is a straight line:

TR = P \times Q

Every extra unit adds exactly $P$ to revenue. So the firm's decision to produce more depends entirely on whether the marginal cost of that unit is less than or greater than this constant MR.

Note

If MR is constant but MC is rising (as it usually does), the firm will keep producing until $MR = MC$ . That is the profit-maximising output.

The Contrast: When MR Is Not Constant

Most real-world firms face downward-sloping demand. To sell more, they must lower the price on all units. So the extra revenue from selling one more unit is less than the price — MR falls as output rises. That is the world of monopoly, monopolistic competition, and oligopoly. …

Start your 14-day free trial to unlock the full solution →

For a price-taking firm, the market price is always equal to its average revenue because it sells all units at the same constant market price.

A price-taking firm operates in a perfectly competitive market. This means it is one of many small firms producing an identical product, and it cannot influence the market price. Instead, it must accept the price determined by the overall market demand and supply. The firm faces a perfectly elastic demand curve at this prevailing market price, meaning it can sell any quantity it wishes at that price, but it cannot sell anything at a higher price.

To understand the relationship between market price and average revenue, let's first define average revenue. Average revenue (AR) is the revenue earned per unit of output sold. It is calculated by dividing the total revenue (TR) by the quantity of output sold (Q).

AR = \frac{TR}{Q}

Total revenue (TR) is the total amount of money a firm receives from selling its output. It is calculated by multiplying the market price (P) by the quantity sold (Q).

$TR = P \times Q$

Now, substitute the expression for total revenue into the average revenue formula:

$AR = \frac{P \times Q}{Q}$

For any firm, regardless of the market structure it operates in, the quantity $Q$ cancels out, leading to the fundamental identity:

$AR = P$

This means that average revenue is always equal to the market price for any firm, whether it is a price-taker or a price-maker. …

Start your 14-day free trial to unlock the full solution →

←Previous questionQ4 — Why is the total revenue curve of a price-taking firm an upward-slopin…→Next questionQ6 — What is the relation between market price and marginal revenue of a pr…

Q.What is the relation between market price and average revenue of a price-taking firm?

🎓Unlock everything free for 14 days

Unlock everything free for 14 days