Demand Curve Elasticity Explained
The relationship between price elasticity of demand, marginal revenue (MR), and average revenue (AR) is crucial for understanding firm behavior.
Marginal Revenue and Elasticity Relationship
The elasticity of a demand curve is directly linked to the sign of the marginal revenue:
- Elastic Demand: When the demand curve is elastic, a decrease in price leads to an increase in total revenue. This happens when marginal revenue (MR) is positive. In this range, quantity demanded changes proportionally more than price.
- Inelastic Demand: When the demand curve is inelastic, a decrease in price leads to a decrease in total revenue. This occurs when marginal revenue (MR) is negative. Here, quantity demanded changes proportionally less than price.
- Unit Elastic Demand: When demand is unit elastic, a change in price results in no change in total revenue. This corresponds to marginal revenue (MR) being zero.
Analyzing Revenue Conditions
Average revenue (AR) typically equals the price of the good, which is generally positive. While AR is related to the demand curve itself (AR = Price), the sign of MR is the direct indicator of elasticity in the relevant range.
- The demand curve is elastic when marginal revenue has a positive value.
- The demand curve is inelastic when marginal revenue has a negative value.
Therefore, the demand curve is elastic when marginal revenue has a positive value and inelastic when marginal revenue has a negative value.
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