Show on a Diagram How a Monopoly Firm Will Make Supernormal Profits by Restricting Ouput

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Show on a diagram how a monopoly firm will make supernormal profits by restricting output. Discuss how the theory of contestable markets could impact on the price and output of a monopoly.

Neo-classical theory defines monopoly as a market structure where one dominant firm supplies most or all output in the industry without facing competition because of high barriers to entry to the industry. The monopolist is a short run profit maximiser and due to the demand under a monopoly being moderately inelastic at any given price, the monopolist is said to be a price maker, unlike perfect competition where the firms are price takers. The diagram below shows the monopoly making supernormal profits by restricting output. The equilibrium profit maximising level of output is 0A where MC = MR, and price will be 0p. Supernormal profits are made, shown by the area on the diagram shaded red. If profit maximisation was not an objective for a monopoly, it might produce at the bottom of its average costs curve (AC). Thus, price being lower than P and quantity produced would be greater. However, because a monopoly is partly defined by wanting to profit maximise in the short run, this is not the case.

mC
AC
Price

Quantity
mR

p
A

Demand

0

Under perfect competition, supernormal profits can only be made in the short run, due to low barriers to entry. The monopolist can earn supernormal profit in the short and long run due to not having to produce at the bottom of the AC curve and having high barriers to entry. These barriers to entry, preventing other potential new entrance from coming in and competing with the monopoly can take various forms. Perhaps the monopoly has control over the source of an essential raw material. Perhaps the monopoly has extremely strong brand loyalty and takes great care to protect its brand image and the loyalty of its consumers through extensive marketing.

It has been shown that neo-classical theory suggests that high barriers to...
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