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

A firm's demand is price elastic at its current output. What follows for its marginal revenue and total revenue?

When demand is price elastic, marginal revenue is positive and a price cut raises total revenue. The proportionate increase in quantity sold is larger than the proportionate fall in price. Marginal revenue turns zero at unit elasticity and negative where demand is inelastic.

  1. AMR is negative, and cutting price lowers total revenue
  2. BMR is positive, and cutting price raises total revenueCorrect
  3. CMR is zero, and total revenue is at its maximum
  4. DMR is positive, and cutting price lowers total revenue
  5. MR equals price, and total revenue is constant

Explanation

When the absolute price elasticity exceeds 1, the percentage rise in quantity exceeds the percentage fall in price. Total revenue rises as price falls, which means MR is positive. MR is zero at unit elasticity and negative when demand is inelastic.

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