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BROOKINGS INSTITUTION: An independent, nonpartisan organization devoted to research, analysis, education, and publication focused on public policy issues in the areas of economics, foreign policy, and governance. The Brookings Institution takes its name from Somers Brookings (1850-1932) who in 1922 and 1924 founded the Institute of Economics and a graduate school bearing his name. These two institutions and the Institute for Government Research (IGR), which was the first private organization devoted to analyzing public policy issues at the national level, merged in 1927 to create the Brookings Institution. The Brookings Institution is a non-profit organization located in Washington, D.C.

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MONOPOLY, REVENUE DIVISION:

The marginal approach to analyzing a monopoly's profit maximizing production decision can be used to identify the division of total revenue among variable cost, fixed cost, and economic profit. The U-shaped cost curves used in this analysis provide all of the information needed on the cost side of the firm's decision. The demand curve facing the firm (which is also the firm's average revenue) and the corresponding marginal revenue curve provide all of the information needed on the revenue side.
The total revenue received by a monopoly is divided among total fixed cost, total variable cost, and economic profit. This division can be illustrated using the marginal approach to analyzing the profit-maximization production decision.

The key to this division is to translate averages indicated by average curves into totals using the quantity produced. For example total revenue can be identified by multiplying average revenue by the quantity produced and total cost is obtained by multiplying average total cost by the quantity.

To see how revenue is divided, consider the production decision undertaken by Feet-First Pharmaceutical, a hypothetical monopoly that controls the production of Amblathan-Plus, the only cure for the deadly (but hypothetical) foot ailment known as amblathanitis. On the revenue side, Feet-First Pharmaceutical is a price maker with market control, meaning it faces a negatively-sloped demand curve.

On the cost side, Feet-First Pharmaceutical's short-run Amblathan-Plus production is guided by increasing, then decreasing marginal returns, which means that its cost is reflected by U-shaped cost curves.

Revenue Division
Revenue Division


The exhibit to the right sets the stage for identifying how the total revenue received by Feet-First Pharmaceutical from Amblathan-Plus production is divided. The profit-maximizing situation illustrated in this exhibit is based on the intersection of two curves--the green, negatively-sloped marginal revenue curve (MR), which is beneath the average revenue (demand) curve, and the U-shaped red marginal cost curve (MC). The intersection of these two curves at 6 ounces of Amblathan-Plus is the profit-maximizing production level. The price charged by Feet-First Pharmaceutical for this quantity is $7.50.

The task at hand is first to identify the total revenue Feet-First Pharmaceutical receives from producing Amblathan-Plus, then to identify the division of this revenue.

  • Total Revenue: Because Feet-First Pharmaceutical is a monopoly, the MR curve is negatively-sloped and below the average revenue curve. The price charged for 6 ounces is thus $7.50 per ounce. Total revenue is then simply the price ($7.50) times the quantity of output (6), which is $45.

    Total revenue can be graphically highlighted as the rectangle bounded by the vertical and horizontal axes on the left and bottom, the $7.50 price on the top, and the vertical line at the quantity of 6 ounces connecting the MR-MC intersection point with the quantity axis on the right. Click the [Total Revenue] button to highlight this area.


  • Total Cost: The next task is to divide Feet-First Pharmaceutical's revenue between the total cost of production and its profit. Much like price times quantity generates total revenue, average total cost times quantity generates total cost. The average total cost of producing 6 ounces of Amblathan-Plus is $6.17 per ounce. This is found at the point where the vertical line designating the profit-maximizing 6 ounces of quantity intersects the ATC curve. Total cost is then average total cost ($6.17) times quantity (6), which is $37.

    This total cost can be graphically highlighted as the rectangle bounded by the vertical and horizontal axes on the left and bottom, the horizontal line indicating $6.17 average total cost on the top, and the vertical line indicating 6 ounces of Amblathan-Plus on the right. Click the [Total Cost] button to illustrate this area.


  • Profit: The difference between the total revenue area and the total cost area is economic profit, equal to $8. This is the smaller rectangle near the top of the total revenue area. It is bounded on the left by the vertical price axis, on the top by the $7.50 price line, on the bottom by the horizontal line indicating $6.17 average total cost, and on the right by the vertical line indicating 6 profit-maximizing ounces of Amblathan-Plus production. Click the [Profit] button to highlight this area.

  • Total Variable Cost: Next up is the division of total cost between total variable cost and total fixed cost. The point at which the vertical line indicating 6 ounces of Amblathan-Plus intersects this AVC curve identifies average variable cost, which is $4.5 per ounce of Amblathan-Plus. Total variable cost is then average variable cost ($4.5) times quantity (6), which is $27. Total variable cost is the lower rectangular area bounded by the vertical and horizontal axes on the left and bottom, the line indicating average variable cost of $4.5 on the top, and the vertical line indicating 6 profit-maximizing ounces of Amblathan-Plus production on the right. Clicking the [Total Variable Cost] button highlights this area.

  • Total Fixed Cost: The last area to identify is total fixed cost. The portion of the total cost area not used for total variable cost goes for total fixed cost. The middle rectangle bounded on the left by the vertical price axis, on the top by the horizontal line indicating $6.17 average total cost, on the bottom by the horizontal line indicating $4.5 average variable cost, and on the right by the vertical line indicating 6 profit-maximizing ounces of Amblathan-Plus production is total fixed cost. Click the [Total Fixed Cost] to highlight this area.

<= MONOPOLY, REALISMMONOPOLY, SHORT-RUN PRODUCTION ANALYSIS =>


Recommended Citation:

MONOPOLY, REVENUE DIVISION, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: June 18, 2024].


Check Out These Related Terms...

     | monopoly, profit maximization | monopoly, loss minimization | monopoly, short-run supply curve | short-run production alternatives | breakeven output |


Or For A Little Background...

     | marginal cost curve | marginal revenue curve | U-shaped cost curves | average total cost curve | average variable cost curve | average revenue curve | marginal cost | marginal revenue | average total cost | average variable cost | average revenue | total revenue | total cost | total variable cost | total fixed cost | profit | economic profit | monopoly | monopoly, characteristics | profit maximization | normal profit | accounting profit |


And For Further Study...

     | monopoly, demand | monopoly, short-run production analysis | monopoly, long-run production analysis | monopoly, efficiency | monopoly, total analysis | monopoly, marginal analysis | monopoly, profit analysis | long run industry supply curve | perfect competition, revenue division |


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