Association of Chartered Certified Accountants (ACCA) Certification Practice Test

How does the firm's average revenue (AR) curve compare to its marginal revenue (MR) curve in the short run?

1. AR will be above MR

2. AR will be below MR

3. AR will be the same as MR

4. AR and MR will intersect

The correct answer is: AR will be the same as MR

In the short run, for a firm operating in a perfectly competitive market, the average revenue (AR) is equivalent to the price of the product being sold. This is because average revenue is calculated as total revenue divided by the quantity of output sold, and in perfect competition, all units are sold at the same price. Marginal revenue (MR), on the other hand, refers to the additional revenue that a firm receives from selling one more unit of output. In a perfectly competitive market, the price remains constant as the firm increases its output because the firm is a price taker. Therefore, when the firm sells an additional unit, the revenue from that additional unit (marginal revenue) is equal to the price of the product, which means MR is also equal to AR. This relationship holds true until the firm reaches a level of output where it must lower the price to sell additional units, which occurs in imperfectly competitive markets. In those cases, MR would fall below AR. However, in the context of perfect competition, both AR and MR are the same at all levels of production. This understanding is crucial for analyzing firm behavior under different market conditions and helps in making strategic decisions regarding output and pricing.