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PERFECT COMPETITION, LOSS MINIMIZATION: A perfectly competitive firm is presumed to produce the quantity of output that minimizes economic losses, if price is greater than average variable cost but less than average total cost. This is one of three short-run production alternatives facing a firm. The other two are profit maximization (if price exceeds average total cost) and shutdown (if price is less than average variable cost).

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AVERAGE REVENUE PRODUCT AND MARGINAL REVENUE PRODUCT:

A mathematical connection between average revenue product and marginal revenue product stating that the change in the average revenue product depends on a comparison between the average revenue product and marginal revenue product. If marginal revenue product is less than average revenue product, then average revenue product declines. If marginal revenue product is greater than average revenue product, then average revenue product rises. If marginal revenue product is equal to average revenue product, then average revenue product does not change.
The relation between average revenue product and marginal revenue product',500,400)">marginal revenue product is one of several that reflect the general relation between a marginal and the corresponding average. The general relation is this:
  • If the marginal is less than the average, then the average declines.

  • If the marginal is greater than the average, then the average rises.

  • If the marginal is equal to the average, then the average does not change.
This general relation surfaces throughout the study of economics. It also applies to average and marginal product, average and marginal cost, average and marginal revenue, average and marginal propensity to consume, and well, any other average and marginal encountered in economics.

Making Tacos

Average and Marginal Revenue Product
Revenue Product Curves
The graph at the right for the hourly production of Super Deluxe TexMex Gargantuan Tacos (with sour cream and jalapeno peppers) illustrates the relation between average revenue product and marginal revenue product.
  • Marginal Greater Than Average : For the first few quantities of variable input (workers), marginal revenue product is rising and lies above average revenue product. This is consistent with an increasing average revenue product. If Waldo (proprietor of Waldo's TexMex Taco World) hires an additional worker in this early stage of production, then the marginal revenue product (that is the extra contribution) of this worker is greater than that of the existing workers. This, as such, increases the average for all workers.

    Even after the law of diminishing marginal returns kicks in, and marginal revenue product declines, average revenue product continues to increase because the marginal exceeds the average.

  • Marginal Equal To Average: The point of intersection between the marginal revenue product and average revenue product curves is also the peak of the average revenue product curve. If the productivity of the marginal worker is equal to the average revenue productivity of the existing workers, then the average does not change.

  • Marginal Less Than Average: Once the marginal revenue product curve moves below the average revenue product curve, then the average revenue product curve declines. As Waldo hires an additional worker in the middle of this range, the marginal revenue product of this worker is less than that of the existing workers, which pulls down the overall average.

The Law of Diminishing Marginal Returns

This average-marginal relation for production is closely tied to the law of diminishing marginal returns. Marginal revenue product, along with marginal product, declines with the onset of diminishing marginal returns. The "hump shape" of the marginal revenue product curve reflects first increasing marginal returns then decreasing marginal returns.

The "hump shape" of the average revenue product curve is thus attributable, indirectly, to the law of diminishing marginal returns and the "hump shape" of the marginal revenue product curve. Increasing marginal returns means marginal revenue product is rising and because average revenue product necessarily starts at zero (zero production means zero average revenue product), marginal revenue product lies above average revenue product and causes it to rise, as well.

With the onset of decreasing marginal returns, marginal revenue product declines. However, for this initial part of the marginal revenue product decline, average revenue product continues rising because marginal revenue product is still greater. After marginal revenue product falls enough to meet up and intersect average revenue product, average revenue product peaks. As marginal revenue product, again guided by the law of diminishing marginal returns, continues to decline and falls below average revenue product. This causes the decline of average revenue product.

In essence, the average revenue product curve plays catch-up to the marginal revenue product curve, sort of follow the leader. At first, marginal revenue product rises, so average revenue product tags along like an annoying younger sibling. Then marginal revenue product decides to fall, so average revenue product chases after it. Because marginal revenue product is guided by the law of diminishing marginal returns, so too is average revenue product.

<= AVERAGE REVENUE PRODUCTAVERAGE REVENUE PRODUCT CURVE =>


Recommended Citation:

AVERAGE REVENUE PRODUCT AND MARGINAL REVENUE PRODUCT, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: September 22, 2018].


Check Out These Related Terms...

     | total product and marginal product | total product and average product | production stages | average product and marginal product |


Or For A Little Background...

     | average-marginal relation | law of diminishing marginal returns | short-run production analysis | average revenue product | marginal revenue product | average revenue product curve | marginal revenue product curve | graphical analysis | marginal analysis | economic analysis |


And For Further Study...

     | total-marginal relation | production possibilities | short-run production analysis | long-run production analysis | law of diminishing marginal utility | law of increasing opportunity cost | U-shaped cost curves |


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