What Happens to Marginal Revenue if the Demand Curve Falls?

In economics, the marginal revenue curve is closely connected to the demand curve. Marginal revenue reflects the additional revenue added by the sale of each additional unit of output, while demand denotes the amount of output consumers are willing to purchase at a given price. If the demand curve changes, marginal revenue will change with it.

For any business, regardless of whether it produces goods or services, the price of the business's output determines how much output the public is willing to buy. For normal goods, demand will decrease as the price increases, although a few exceptions exist. The demand curve is a graphed curve that shows this relationship on a chart where the axes represent quantity of output and price. Conventionally, price is the vertical axis and output the horizontal one.

Marginal revenue is the marginal addition to revenue added by the next unit of output sold. As a function, it is the derivative of the total revenue curve, which is found by inverting the demand function and then multiplying that by quantity. Marginal revenue curves, which are described by marginal revenue functions, usually have the same intercept as demand but half the slope. They are graphed using the same axes as the demand curve.

Because marginal revenue is partially based on the inverted demand curve, if something changes demand, marginal revenue will also change. A shift in demand would be reflected graphically as the demand curve shifting downward and inward: the intercept of the curve would decrease. Marginal revenue shares the same intercept as demand, so it moves down by the same amount. A shift in the demand curve by a given amount will shift the marginal revenue curve by the same amount and in the same direction.

Many factors can influence the demand curve. A rival product might appear with a cheaper price, for instance, which would attract customers and reduce demand for the original. This phenomenon is known as substitution. For example, a company selling coffee might lose customers to a new competitor that starts selling tea at a lower price. Demand could also increase if a complementary good becomes cheaper -- that is, a good that increases utility for consumers when consumed with the original. For example, the company selling coffee could see an increase in demand if sugar or milk become cheaper, because people often add those to coffee. There are many possible sources of demand changes, most of which are outside the producer's control.