Types of competition and marginal revenue | APⓇ Microeconomics | Khan Academy

We've already had several videos where we talk about the types of markets that we might look at in economics. At one end, you might have perfect competition.

Let's write perfect comp. This is where you have many firms. What they produce is not differentiated; there's no barriers to entry. In that situation, we have looked at that the market price, and the firms just have to take that market price. That market price is going to describe what their marginal revenue is going to be.

No matter how much each of those individual firms produce, they're just going to get that market price. So that marginal revenue will be that market price.

But then we looked at a whole sort of what we could call imperfectly competitive firms. Imperfectly imperfect competition at the extreme, you have the monopoly where you only have one firm in the market, huge barriers to entry. That company, or that firm, essentially is the market.

So their demand curve for their product essentially is the market demand curve. But in between, you have things like monopolistic competition right over there. In monopolistic competition, you have many firms that are competing, but they're all differentiated in some way, and there are some barriers to entry.

A good example of monopolistic competition or imperfect competition might be the athletic shoe market. In the athletic shoe market, you have many competitors. You have your Nike, Adidas, Reebok, and I could keep listing names.

They are all differentiated in their own way; they all have their own brands which they've built up over time. They have associations with certain sports figures. Some of their shoes might be perceived as better in certain categories, but they are also competing with each other.

So the competition is that they're competing with each other, but you could consider it monopolistic competition because only Nike can sell well Nike shoes. So you can imagine a demand curve for, say, only Nike shoes.

In an imperfect competition, every firm would have their own unique demand curve, and how much they produce actually will affect the price that they get for the product or the service.

What we're going to see in this video is that when we're dealing with imperfect competition, the demand curve, the price isn't exactly what marginal revenue is going to be. To understand that, let's look at a simple model here.

So right over here, I have a very simple model of a demand curve for a firm in an imperfectly competitive market. You can see here that the more that that firm produces of its goods, the lower pricing they can get for that good.

We can see very clearly this is a classic downward sloping demand curve. But what's going to be really interesting is to think about what is going to be the marginal revenue, especially the marginal revenue in a world where if they sell one unit, they get $32.50.

But when they sell two units, it's not like they'll get $32.50 for one of those units, and then they'll get $25 for the second unit. If you have a market price out there for $25, you're going to get $25 on all two units.

So even though someone was willing to pay $32.50 for one, they're still only going to pay $25. So let's think about what that does to the marginal revenue. I encourage you to pause this video and try to fill out this table yourself before I do it with you.

All right, now let's do it together. So our total revenue, obviously when we sell nothing, we have—let me do this in another color—we have zero total revenue.

Now, when we sell one unit at $32.50, well then our total revenue is going to be $32.50—no surprise there. Now it's going to get interesting when we sell two units. What's going to be our total revenue?

Well, both of those units are going to be sold at $25. It's not like, as I just said, it's not like that first person is still willing to pay $32.50. It's like, "Hey, your market price is $25; that's what everyone's going to pay."

So now your total revenue is $50—two times $25. Now, when you go to three, the market price that you can get is $17.50. Let's see, that is going to be $50 to $50—$250 of total revenue.

If your market price was $10, you could have a quantity of four. If you wanted to sell four, you could do so at a price of $10. You can view it either way, but then your total revenue is going to be $40.

Now, from this, we can think about, well, what's our marginal revenue? Well, our marginal revenue for that first unit is the same as what the price of that first unit is. We went from $0 to $32.50 with that first unit, so that's $32.50 right over here.

But what about as we go from that first unit to that second unit? Well, our units go up by one, but our revenue from $32.50 to $50 goes up by $17.50. And so you're already seeing that there's a discrepancy between our marginal revenue and our price.

We can keep going. When we go from two to three units, our revenue only goes up by $250, and so that's going to be our marginal revenue.

Then something very interesting happens. As we go from three units to four units, our total revenue actually goes down. It goes down by $12.50—negative $12.50 right over here.

That's because when the price gets that low, you are taking a hit on all of the units that you're selling. So you actually get a lower total revenue right over here.

If we plot it, we can see very clearly that the marginal revenue curve departs from the demand curve for that firm that's competing in an imperfectly competitive market.

At one unit, our marginal revenue is the same, but at two units, our marginal revenue is $17.50. At three units, our marginal revenue is $250.

So we have a marginal revenue curve that looks more like this. The big takeaways here are that a firm that's operating in an imperfectly competitive market isn't just a price taker.

It's not that no matter how much it produces, it's going to get the same price. It's going to have its own unique demand curve because there is some differentiation in the market.

It's going to have a downward sloping demand curve, and because of that downward sloping demand curve, you are also going to have a downward sloping marginal revenue curve.

That marginal revenue curve is actually going to be downward sloping at a steeper rate. So when we start doing the firm analysis of marginal cost and where it intersects the marginal revenue, if you're dealing with a firm that's operating in a perfectly competitive market, that marginal revenue curve, when we've seen it before, was horizontal.

But when we think about that marginal revenue curve for a firm in an imperfectly competitive market, that's going to be downward sloping, and it's going to be sloping downward faster than its demand curve.