Ap

a a marginal revenue curve intersects the horizontal axis at / Qx, given that the demand curve intersects at Qx. Figure 5.4(a) shows that marginal revenue is positive in the range where demand is price elastic, zero where €P = -1, and negative in the inelastic range. Thus, there is an obvious relation between price elasticity and both average and marginal revenue.

As shown in Figure 5.4(b), price elasticity is also closely related to total revenue. Total revenue increases with price reductions in the elastic range (where MR > 0) because the increase in quantity demanded at the new lower price more than offsets the lower revenue per unit received at that reduced price. Total revenue peaks at the point of unitary elasticity (where MR = 0), because the increase in quantity associated with the price reduction exactly offsets the lower revenue received per unit. Finally, total revenue declines when price is reduced in the inelastic range (where MR < 0). Here the quantity demanded continues to increase with reductions in price, but the relative increase in quantity is less than the percentage decrease in price, and thus is not large enough to offset the reduction in revenue per unit sold.

The numerical example in Table 5.2 illustrates these relations. It shows that from 1 to 5 units of output, demand is elastic, I €P I > 1, and a reduction in price increases total revenue. For example, decreasing price from $80 to $70 increases the quantity demanded from 3 to 4 units. Marginal revenue is positive over this range, and total revenue increases from $240 to $280. For output above 6 units and prices below $50, demand is inelastic, I €P I < 1. Here price reductions result in lower total revenue, because the increase in quantity demanded is not large enough to offset the lower price per unit. With total revenue decreasing as output expands, marginal revenue must be negative. For example, reducing price from $30 to $20 results in revenue declining from $240 to $180 even though output increases from 8 to 9 units; marginal revenue in this case is -$60.

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