AR-MR Relationship Under Different Market Conditions

Whether AR and MR move together or apart depends entirely on the shape of the demand curve the firm faces — which in turn depends on the market condition the firm operates under.

Under perfect competition, an individual firm is a "price taker": it is too small, relative to the whole market, to influence the price by changing its own output, so it faces a perfectly elastic (horizontal) demand curve at the ruling market price — it can sell any quantity it wishes at that one unchanged price. Since every additional unit sells at the SAME price as all previous units, the addition to total revenue from one more unit (MR) is always exactly equal to that constant price, which is also AR. Hence under perfect competition, $AR = MR = \text{Price}$, shown as a single horizontal straight line — this is exactly the pattern in the Rs. 20 schedule of the previous section.

Under imperfect competition (including monopoly), the firm faces a DOWNWARD-SLOPING demand curve: to sell a larger quantity, it must LOWER the price — and crucially, this lower price applies to ALL the units it sells, not merely to the extra unit. Selling one more unit therefore adds LESS to total revenue than the price at which that extra unit itself is sold, because the firm also loses a little revenue on every earlier unit (each of which must now also be sold at the new, lower price). Consequently, under imperfect competition, MR is always LESS than AR at every output beyond the very first unit, and the MR curve lies entirely below the AR (demand) curve. For a straight-line (linear) AR curve, MR is also a straight line that starts from the SAME point on the price axis but falls at exactly TWICE the numerical slope of AR — so MR reaches zero at exactly half the output at which AR (demand) itself would reach zero. …