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MONOPOLISTIC COMPETITION, REVENUE DIVISION:

The marginal approach to analyzing a monopolistically competitive firm's short-run 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) together with the marginal revenue curve provides all of the information needed on the revenue side.
The total revenue received by a monopolistically competitive firm 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 Manny Mustard's House of Sandwich, a hypothetical monopolistically competitive firm, in the production of his famous Deluxe Club Sandwich. On the revenue side, Manny is a monopolistically competitive price taker with minimal market control. Because Manny's sandwiches are similar but not identical to those supplied by thousands of other eating establishments, he has limited market control and faces a relatively elastic demand curve. He has some flexibility in the price charged, but not much.

On the cost side, Manny's short-run sandwich production is guided by increasing, then decreasing marginal returns, which means that his 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 Manny receives from sandwich production is divided. The profit-maximizing situation illustrated in this exhibit is based on the intersection of two curves--the negatively-sloped green marginal revenue curve (MR) and the U-shaped red marginal cost curve (MC). The intersection of these two curves at 6 sandwiches is the profit-maximizing production level.

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

  • Total Revenue: Because Manny is a monopolistically competitive firm, the MR curve is negatively-sloped and below the average revenue curve. The price charged for 6 sandwiches is thus $4.95 per sandwich. Total revenue is then simply the price ($4.95) times the quantity of output (6), which is $29.70.

    Total revenue can be graphically highlighted as the rectangle bounded by the vertical and horizontal axes on the left and bottom, the $4.95 price on the top, and the vertical line at the quantity of 6 sandwiches 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 Manny'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 6 sandwiches is $3.65. This is found at the point where the vertical line designating the profit-maximizing 6 sandwiches of quantity intersects the ATC curve. Total cost is then average total cost ($3.65) times quantity (6), which is $21.90.

    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 $3.65 average total cost on the top, and the vertical line indicating 6 sandwiches 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 $7.80. 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 $4.95 price, on the bottom by the horizontal line indicating $3.65 average total cost, and on the right by the vertical line indicating 6 profit-maximizing sandwiches 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 6 sandwiches intersects this AVC curve identifies average variable cost, which is $3.15 per sandwich. Total variable cost is then average variable cost ($3.15) times quantity (6), which is $18.90. Total fixed cost is the difference between total cost ($21.90) and total variable cost ($18.90), 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 $3.15 on the top, and the vertical line indicating 6 profit-maximizing sandwiches of 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 $3.65 average total cost, on the bottom by the horizontal line indicating $3.15 average variable cost, and on the right by the vertical line indicating 6 profit-maximizing sandwiches of production is total fixed cost. Click the [Total Fixed Cost] to highlight this area.
Before leaving Manny and his sandwich production, consider just how lucky Manny has been. The market price is high enough to generate economic profit. This $4.95 sandwich price generates sufficient total revenue for Manny to pay all cost--total variable cost and total fixed cost. However, should his demand decrease, then Manny would have to reevaluate his production decision. If the demand declines enough, Manny could incur a loss and be forced to decide if it is worthwhile to continue in the sandwich business.

<= MONOPOLISTIC COMPETITION, PROFIT MAXIMIZATIONMONOPOLISTIC COMPETITION, SHORT-RUN PRODUCTION ANALYSIS =>


Recommended Citation:

MONOPOLISTIC COMPETITION, REVENUE DIVISION, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2021. [Accessed: October 26, 2021].


Check Out These Related Terms...

     | monopolistic competition, profit maximization | monopolistic competition, loss minimization | monopolistic competition, shutdown | monopolistic competition, 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 | monopolistic competition | monopolistic competition, characteristics | profit maximization | normal profit | accounting profit |


And For Further Study...

     | monopolistic competition, demand | monopolistic competition, short-run production analysis | monopolistic competition, long-run production analysis | monopolistic competition, efficiency | monopolistic competition, total analysis | monopolistic competition, marginal analysis | monopolistic competition, profit analysis | long run industry supply curve |


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