Question

Show the AR and MR curves in monopolistic competition through a diagram.

Hint:

In monopolistic competition, the MR curve lies below the AR curve because the firm must lower prices to sell more units.

Answer 1

Step 1: Defining AR and MR Curves in Monopolistic Competition:
In monopolistic competition, firms sell products that are similar but not identical, meaning they have some degree of market power. The Average Revenue (AR) curve represents the price at which a firm can sell a given quantity of output, while the Marginal Revenue (MR) curve represents the additional revenue generated by selling one more unit of output.
Step 2: Characteristics of AR and MR Curves in Monopolistic Competition:
- AR Curve: The AR curve in monopolistic competition is downward sloping, reflecting the fact that in order to sell more units, the firm must lower its price. The AR curve coincides with the demand curve.
- MR Curve: The MR curve lies below the AR curve. This is because, in monopolistic competition, when a firm reduces the price to sell an additional unit, it must lower the price for all previous units as well, which causes the additional revenue (MR) to be less than the price (AR) at each level of output.
Step 3: Diagram Explanation:
Here’s how the AR and MR curves are typically drawn:
1. The AR curve is downward sloping.
2. The MR curve starts at the same point as the AR curve but falls more steeply.
3. The difference in slope between AR and MR arises because to sell more units, the firm has to reduce prices for all units sold, making the marginal revenue less than the price.
Step 4: Final Conclusion:
The AR curve is downward sloping in monopolistic competition, and the MR curve lies below it, with both curves reflecting the firm’s price-output decisions in the face of limited competition.