Revenue in Monopolistic Competition - Online Tutor, Practice Problems & Exam Prep

In monopolistic competition, firms face a downward sloping demand curve, leading to a marginal revenue that is always less than the price of the good. When price decreases, the price effect reduces revenue per unit, while the output effect increases total units sold. Total revenue is calculated as price times quantity, and average revenue equals price. The marginal revenue curve lies below the demand curve, impacting profit calculations where marginal revenue equals marginal cost. Understanding these dynamics is crucial for analyzing market structures and firm behavior in economics.

Monopolistic Competition Revenue

Alright, now let's discuss some of the key ideas about revenue in monopolistic competition. Before we dive in here, I just want to make a point. If you've already studied monopoly market structures, well, this is the same exact page. Revenues for monopolistic competition and revenues for monopolies are exactly the same. We do all the same things here. There's just the implications of that overall market structure, right, where a monopoly is the only producer in the whole market and monopolistic competition, well, there are other competitors in this market where a monopoly doesn't have that competition. However, you're going to see that we treat revenue just the same and on top of that, we calculate profit just the same as we do with the monopoly. Alright, so let's dive in here and you're going to see all the similarities. If you haven't done monopolies yet, well, I'm going to do the same little spiel when you see that video.

Alright, so what we're going to see is that firms in monopolistic competition face a downward-sloping demand curve, right? That's what we saw when we first discussed our demand curves. Downward sloping demand curve and we're going to talk about a price decrease, right? So we saw that we had a downward-sloping demand curve and we're going to have effects on our quantity and our price when we're changing, right, because it's downward sloping. Now, we're going to discuss what happens when we decrease price and now we've gone into more detail about this price effect and output effect in this video called total revenue test and this was back when we were studying elasticity.

We went through the price effect and output effect, but let's just go over it on a high level here. If you want more information, you can go back to that video and we go into a lot more detail. If we're going to decrease the price, what's going to happen? We're going to have 2 effects on our revenue. The first thing that's going to happen is the price effect. So we decreased our price, so we're going to get less revenue per unit. There's going to be a lower price so every unit we sell, we're going to sell at a lower price and earn less revenue. We earn less revenue per unit sold at that lower price. But the other side effect is the output effect. These are always going to be opposite of each other. If the price effect lowers our revenue, the output effect is going to increase it. The idea here is at that lower price, we're going to sell more units. Because we lowered the price, the quantity demanded is going to increase. And it would be the opposite for a price increase you could imagine. If we were going to increase the price, well the price effect would get us more revenue because it's a higher price bringing in more revenue per unit, but since it's a higher price, we don't sell as many. So the output effect would have been less revenue in that case.

What this tells us is that in a monopolistically competitive market, the firm's marginal revenue is always less than the price of the good and that's because of this price effect and output effect. There's always going to be one factor that's lowering our revenue and we can't keep that constant marginal revenue like we saw in perfect competition. Let's go ahead and dive into this idea of less marginal revenue here. We'll pause right here and we'll start it up in the next video. We'll do the example just right now. Cool? Let's do it.

Monopolistic Competition Marginal Revenue

Alright, so this is the same example that we do in the monopoly chapter as well, okay? But here, we're discussing a market for cable subscriptions. When we dealt with a monopoly, I mentioned that it was maybe the only provider of cable for a small town, right? They were the only provider, so they had full control over that market in a monopoly. Well, here in monopolistic competition, the difference is that there are other cable providers. So maybe you're in a bigger city, and you don't have just one option. You might have a couple of different cable companies, maybe you can get satellite TV. They're each going to be differentiated in what channels they offer, what products they offer to you, like movie channels, but they are also going to be similar in that they're offering you television programming. Cool? So we're going to keep our example simple here. We've got a different amount of subscribers, and as we decrease the price, notice that the quantity of subscribers is increasing. Lower prices mean more subscribers. Cool. So let's go ahead and calculate some of our revenue numbers.

So first let's start here with total revenue, and we've discussed this before that it's just price times quantity, right? So we're just going to do some multiplication across here. The price being 80, well there's 0 subscribers, so there's 0 revenue. When a price is 70 with 1 subscriber, 70 × 1, we're going to get 70. 60 × 2 is 120. 50 × 3 is 150. 40 × 4 is 160 and then 30 × 5 is 150 again. You notice it was increasing to a point and then started decreasing again. Right? Well, when we do it like this, it's pretty clear to see where we're making the most revenue, right? Obviously, at 4 units we've got the most revenue, but what we're usually going to do is deal with this on the graph.

So let's go ahead and finish up our average revenue and our marginal revenue and then we'll check these out on the graph. So let's go ahead and calculate average revenue and remember that average revenue is just equal to price and we've proved that out in the perfect competition chapter when we were talking about revenue. We proved out how average revenue equals price and that's just the total revenue divided by the quantity and we'll just double-check it here, okay? Well, quantity is 0 here. We can't divide by 0, so there's not going to be an average revenue here. How about the next one? One? Our total revenue was 70 divided by 1 subscriber, well that equals 70, right? Total revenue divided by quantity is 70 there and that equals our price, right? Price of 70, price of 70, average revenue of 70. Right? So let's see if this continues. How about the next one? Total revenue of 120 divided by quantity of 2. 120 divided by 2 is 60, right? And 60 is our price. Right? So average revenue equals price and that's going to keep going all the way down here. Price was 50 there, price was 40, price was 30. Okay?

So what does this show us is that the average revenue is equal to our demand curve. This curve that I've shown over here is our demand curve which is equal, I put average revenue equals the demand curve, right? Price equals average revenue equals the demand curve. Cool?

Alright. So look, these are all the points that we have. When we had 1 subscriber here, we had average revenue of 70, right? 2 subscribers, average revenue of 60, average revenue of 50 with 3. Right? So there is our demand curve and it has to do with that average revenue.

How about our marginal revenue curve? Let's check that one out now. So remember marginal means what happens when we add 1. So if we add 1 more unit, how much more revenue are we going to get, right? So we're going to change our quantity, our change in revenue over our change in quantity where this change in quantity is usually going to be 1, right? Most of our examples oh, you can't see that. 1, right? So let's go ahead and do that. Let's see what it is. Our change in quantity is always 1, so we just need to find our change in total revenue here. Okay, so our total revenue was 0 when we had 0 subscribers and then it went up to 70, right? So it went from 0 to 70. Our marginal revenue is 70 there for that first unit, right? We can't do it for the first one cause there wasn't there's nothing before it, right? No change on the first one, we're only looking where there's a change in the number of units. Okay, how about the second unit? The second unit, we already had 70 in revenue and then we sold the 2nd unit and it brought our total revenue up to 120, right? So we got an extra 50 in revenue. 120, minus the 70, that gives us an extra 50 in revenue. How about the next one? We already had 120 in revenue and it got up to 150, so that's an extra 30 in revenue, right? 120 to 150, there's 30, an increase there. How about from 150 to 160? Well, it increased by 10, right? It was 150, went up to 160, that's a 10 increase, and then this last one, we were at 160 and then it went down to 150, right? So we have negative marginal revenue, we've lost revenue by adding this next unit, okay? So marginal revenue can get negative like that and what we're going to end up seeing is a marginal revenue curve something like this. So at 1 unit, we were at 70. At 2, we were at 50. At 3, we're at 30. At 4, we're at 10. And 5, we're negative. So we would have been somewhere under the graph there. So we're going to end up with some marginal revenue curve that looks like this. Here, let me do it with this. Let's see if this works. Alright, that that's kind of cool and I don't like it too much though actually. I'm going to draw it in by hand. So our marginal revenue curve is decreasing there something like that and notice that it's under our demand curve, right? It's always going to be less than our demand curve. That's just how this works, the marginal revenue is always going to fall under the demand curve and that has to do with that downward sloping demand. Okay? So our marginal revenue is going to keep decreasing like that and you can tell that that's going to have some implications when we start dealing with profit, right? Remember that the key point when we were talking about profit and perfect competition was marginal revenue equals marginal cost and now you can see that this is going to have some effect on that calculation in this chapter. Alright, so that's the main takeaway here is that the marginal revenue curve falls under the demand curve.

It's going to always be less than the demand, so let's go ahead and do some practice before we move on to calculating profit. Alright, let's do that now.

Which of the following statements is true?

• A. A monopolistically competitive firm's demand curve is equal to the market demand curve.
• B. For a monopolistically competitive firm, an increase in the quantity sold will always increase total revenue.
• C. The barriers to market entry in perfect competition are more stringent than those for monopolistic competition.
• D. A monopolistically competitive firm's marginal revenue is less than its average revenue.

In monopolistic competition, firms have ________ power to set the price of its produce because ________

• A. No; there are no barriers to entry
• B. Some; of product differentiation
• C. No; of product differentiation
• D. Some; there are barriers to entry

Here’s what students ask on this topic:

What is the difference between revenue in monopolistic competition and perfect competition?

In monopolistic competition, firms face a downward sloping demand curve, meaning that marginal revenue (MR) is always less than the price of the good. This is due to the price effect and output effect. In contrast, in perfect competition, firms face a perfectly elastic demand curve, so MR equals the price. This difference impacts how firms in each market structure calculate profit. In monopolistic competition, the MR curve lies below the demand curve, while in perfect competition, the MR curve is the same as the demand curve.

How do you calculate total revenue in monopolistic competition?

Total revenue (TR) in monopolistic competition is calculated by multiplying the price (P) by the quantity (Q) sold. The formula is:

$\mathrm{TR}=P\times Q$

For example, if a firm sells 4 units at a price of $40 each, the total revenue would be:

$\mathrm{TR}=40\times 4=160$

Why is marginal revenue always less than price in monopolistic competition?

In monopolistic competition, marginal revenue (MR) is always less than the price due to the downward sloping demand curve. When a firm lowers its price to sell more units, the price effect reduces revenue per unit, while the output effect increases the total number of units sold. However, the additional revenue from selling more units is less than the price because the firm must lower the price on all units sold, not just the additional ones. This results in MR being less than the price.

How does the marginal revenue curve relate to the demand curve in monopolistic competition?

In monopolistic competition, the marginal revenue (MR) curve lies below the demand curve. This is because the firm must lower the price to sell additional units, which affects all units sold, not just the marginal unit. As a result, the additional revenue gained from selling one more unit (MR) is less than the price at which the unit is sold. The demand curve represents the price consumers are willing to pay for each quantity, while the MR curve shows the additional revenue from selling one more unit.

What is the price effect and output effect in monopolistic competition?

The price effect and output effect are two opposing forces that impact revenue in monopolistic competition. The price effect occurs when a firm lowers its price, resulting in less revenue per unit sold. The output effect happens because the lower price increases the quantity demanded, leading to more units sold. These effects work in opposite directions: the price effect decreases revenue, while the output effect increases it. The net impact on total revenue depends on the relative strength of these two effects.