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 Phil the zucchini gardener, a hypothetical perfectly competitive firm. On the revenue side, Phil is a perfectly competitive price taker with no market control. Because Phil's zucchinis are identical to those supplied by gadzillions of other zucchini growers nationwide, he has no market control and faces a perfectly elastic demand curve at the going market price of $4 per pound.

On the cost side, Phil's short-run zucchini production is guided by increasing, then decreasing marginal returns, which means that his cost is reflected by U-shaped cost curves.

Revenue Division

The exhibit to the right sets the stage for identifying how the total revenue Phil receives from zucchini production is divided. The profit-maximizing situation illustrated in this exhibit is based on the intersection of two curves--the horizontal, perfectly elastic green marginal revenue curve (MR), which is also the demand curve Phil faces when selling zucchinis, and the U-shaped red marginal cost curve (MC). The intersection of these two curves at 7 pounds of zucchinis is the profit-maximizing production level.

The task at hand is first to identify the total revenue Phil receives from producing zucchinis, then to identify the division of this revenue.

• Total Revenue: Because Phil is a perfectly competitive firm, the MR curve is also average revenue and the product price, $4 per pound. Total revenue is then simply the price ($4) times the quantity of output (7), which is $28.

  Total revenue can be graphically highlighted as the rectangle bounded by the vertical and horizontal axes on the left and bottom, the MR curve on the top, and the vertical line at the quantity of 7 pounds 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 Phil's revenue between the total cost of production and his profit. Unfortunately the MC is not sufficient for this task. Other cost information is needed, in particular, the average total cost curve. Click the [ATC Curve] button to add this curve, labeled ATC, to the graph. Much like price times quantity generates total revenue, average total cost times quantity generates total cost. The average total cost of producing 7 pounds of zucchinis is $3 per pound. This is found at the point where the vertical line designating the profit-maximizing 7 pounds of quantity intersects the ATC curve. Total cost is then average total cost ($3) times quantity (7), which is $21.

  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 $3 average total cost on the top, and the vertical line indicating 7 pounds of zucchinis 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 $7. 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 MR curve, on the bottom by the horizontal line indicating $3 average total cost, and on the right by the vertical line indicating 7 profit-maximizing pounds of zucchini 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. This division is possible by adding one more curve to the graph--the average variable cost curve. Click the [AVC Curve] button to add this curve, labeled AVC, to the graph. The point at which the vertical line indicating 7 pounds of zucchinis intersects this AVC curve identifies average variable cost, which is $2.57 per pound of zucchinis. Total variable cost is then average variable cost ($2.57) times quantity (7), which is $18. Total fixed cost is the difference between total cost ($21) and total variable cost ($18), which is $3. 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 $2.57 on the top, and the vertical line indicating 7 profit-maximizing pounds of zucchini 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 $3 average total cost, on the bottom by the horizontal line indicating $2.57 average variable cost, and on the right by the vertical line indicating 7 profit-maximizing pounds of zucchini production is total fixed cost. Click the [Total Fixed Cost] button to highlight this area.