What Is the Relationship Between Price Elasticity & Marginal Revenue?

There's a direct relationship between price elasticity and marginal revenue. The more elastic a good is, the more its demand is affected by changes in supply. In a competitive market, marginal revenue is the same as price. Therefore, in a competitive market, price elasticity has a direct relationship with marginal revenue. In a natural monopoly, marginal revenue is less than price. This is because low price is a primary driver of monopoly. Therefore, in a monopoly, price elasticity also has a direct relationship with marginal revenue.

In the world of microeconomics, goods are either elastic or inelastic. The demand for an elastic good is heavily influenced by price. For example, there are many different brands of almond butter. There are also many different substitutes for the product, including peanut butter and cashew butter. For this reason, an increase in price will decrease demand as customers opt for a lower-priced product. The more demand changes with price, the more elastic a good is.

An inelastic good is one where changes in price do not change demand. If you raise the price of a life-altering drug, it will not change demand, and substitutes rarely exist for life-altering drugs. Only legal monopolies exist for price-inelastic goods, since price is not a driver of demand. A legal monopoly is created by a patent, copyright or exclusive right to the use of intangible asset.

Marginal revenue is the incremental revenue for each unit sold. A company that sells high-volume products benefits from economies of scale, which allows them to lower prices, which increase sales volume. To keep demand high, the price is lowered even more. The more a company sells, the more it can save, and the more of those savings can be passed along to the customer. The natural monopoly is driven by the low-cost leader.

Marginal revenue is driven by price and cost, which are both a function of demand. Higher prices and lower costs generate higher revenues. Higher volume generates higher revenue through economies of scale and lowers costs. The effect is cyclical, and the benefit of saving costs is countered with the loss of revenue from lower prices. If the good is price inelastic, changes in price will not affect demand. Since demand is unaffected by price, an increase in price will increase revenue. Additionally, the cost saves from volume increases do not need to be passed along to the customer.