Exploring Marginal Revenue and Elasticity

7. Marginal revenue and elasticity are related. Let us see if you can figure out how they are related in the following situations:

a) If the firm is a price taker, it faces a perfectly flat demand curve. This demand curve is perfectly elastic; that is, its elasticity is infinity. What is true of the marginal revenue relative to price in this case? (Hint: Use the equation that links marginal revenue and elasticity.)

b) If elasticity is unitary elastic (that is, has a value of 1), what will be the value of marginal revenue?

c) If elasticity is less than 1, what range of values can marginal revenue take? In this case, what will happen to total revenue if the firm sells more by cutting price?

d) If elasticity is greater than 1, what range of values can marginal revenue take? In this case, what will happen to total revenue if the firm sells more by cutting price?

e) Fill in the following table, pulling down the menus to place the words "Increase," "Decrease," and "Not Change" where they belong.

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IF		and the firm increases sales, total revenue will:	and the firm decreases price, total revenue will:
e < 1 (inelastic)		?? Increase Decrease Not Change	?? Increase Decrease Not Change
e = 1 (unitary elastic)		?? Increase Decrease Not Change	?? Increase Decrease Not Change
e > 1 (elastic)		?? Increase Decrease Not Change	?? Increase Decrease Not Change

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