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IAI Actuarial Core Principles · Business Economics · Profit maximisation under imperfect competition

A firm in monopolistic competition faces a downward-sloping linear demand curve. Which statement correctly describes its marginal revenue (MR) curve relative to the demand (average revenue) curve?

Marginal revenue lies below the demand curve for a firm facing downward-sloping demand. To sell more, the firm lowers the price on all units, so the extra revenue from one more unit is less than its price. Only a price taker has MR equal to price.

  1. AMR lies above the demand curve at every output level
  2. BMR coincides with the demand curve at every output level
  3. CMR is horizontal while demand slopes downward
  4. DMR lies below the demand curve, because selling more requires a lower price on all units soldCorrect
  5. MR slopes upward while demand slopes downward

Explanation

To sell an extra unit the firm must cut the price on all units, so the revenue gained from the extra unit is the new price minus the revenue lost on earlier units. MR is therefore below price (AR) at all positive outputs. MR coincides with demand only for a price taker, who faces a horizontal demand curve.

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