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Under perfect competition, the demand curve which an individual seller has to face is perfectly elastic, i.e., it runs parallel to the base axis. The competitive seller being unable to affect the market price sells its output at prevailing market price. Hence marginal revenue, equals the price of the product. The average revenue is identical to its marginal revenue. Thus under perfect competition:

MR = AR = Price and the Three Curves Coincide and are Perfectly Elastic

This is, however, not the case under monopoly. The monopolist is the, sole supplier of a product in the market. He has full powers to make decisions about the pricing of his product. He is a price maker, if he lowers the unit price of his product, his sale is increased. If he raises the price, he will not lose all his sale. The demand curve facing the monopolist thus slope downward from left to right.

Demand in Monopolistic Market:

As the monopolist’s demand curve is negatively sloped, the marginal revenue is here no longer equal to price or average revenue. It is less than the average price (AR) at every level of output, except the first.

The relation between marginal revenue and average revenue is explained with the help of a schedule and a diagram.

Schedule:

In the above schedule, it is shown that as the monopolist lowers price of his product from $100 per meter to $80 per meter in specified period of time, the sale increase from one unit to two units. The total revenue resulting from the sale of one more unit increases by $60 (MR); whereas the additional unit has been sold for $80. The reason for the total revenue not to increase by the same amount is that the price has been reduced for increasing the sale of the extra units. The price cut is applied to two units of output sold and not to the additional unit alone. Same is the case with the third, fourth and fifth units sold. The marginal revenue is less than the price ATR (AR) for all the units of commodity disposed off in the market.

Diagram:

As the marginal revenue is always less than price, the marginal revenue curve, therefore, remains below the average revenue curve or demand curve as is illustrated. In the figure (16.1), the demand curve which also represents average revenue curve has a downward slope. The demand curve is downward sloping because the monopolist can sell greater output only by reducing the price of units of output.

The marginal revenue curve of the monopolist always lies below the demand curve because the marginal revenue from the sale of additional unit of output is less than its price.

Relationship between Monopoly Price and Elasticity of Demand:

The total revenue test can be applied for explaining the monopoly price and its relationship to price elasticity of demand. The total revenue test tells us that when demand is elastic, a decline in price will increase total revenue. When demand is inelastic, a decline in price of a good will decrease its revenue. Applying this test, a monopolist will fix the amount of his product at a level where the elasticity of his average revenue curve is greater than one (E > 1). It causes total revenue to increase.

Here marginal revenue is positive. A monopolist does not push his produce to the point where the marginal revenue becomes negative. The monopolist choice of price when faced with varying degree of elasticities are now explained with the help of a linear average revenue function (price line) in fig 16.2.

At midpoint on the down sloping AR curve, elasticity of demand is equal to one, (E = 1). Above point P, elasticity is greater than one, (E > 1) and below less than one (E < 1). At price MP, marginal revenue is zero. At prices above than MP, MR is positive and below it marginal revenue is negative. The monopolist would not like to increase his safes up to a point where his MR becomes negative or his total revenue starts decreasing. The monopolist chooses the price quantity combination where the MR is positive and the elasticity of demand is more than one.