MR, MC and Demand Curve under Monopolistic Competition

In monopolistic competition, the demand curve given by the average revenue curve slopes downward. This implies that a firm can sell more units at a lower price. Here, the demand curve is relatively elastic due to the availability of close substitutes.

The marginal revenue curve also slopes downward and lies below the demand curve, decreasing at a faster rate. Consider a coffee shop that lowers prices to attract more customers. To sell more cups, the price of all cups must be reduced, not just the additional ones. While it gains revenue from selling the extra cup at the new lower price, it loses revenue on previous cups that could have been sold at the old, higher price. As a result, marginal revenue is always less than the price per cup, which is the average revenue. This causes the MR curve to lie below the AR curve.

On the other hand, the marginal cost curve initially decreases and then increases, forming a U-shape.

Together, these curves show how the firm makes decisions about pricing and production.