Theory question 106
Market StructuresSection B: answer three questions only from this section.
With the aid of a diagram, explain the super-normal profit of a monopolist.
Show the model answer
Model answer
Diagram: price/cost on the vertical axis, quantity on the horizontal axis; downward-sloping AR (demand) curve with MR below it; U-shaped MC and AC curves
The monopolist produces where MC = MR, giving output OQ
Price OP is read from the AR (demand) curve at OQ
Average cost at OQ is ON, below the price
Total revenue = OP × OQ; total cost = ON × OQ
Super-normal profit = (OP − ON) × OQ, the shaded rectangle PNAB (price above AC)
Because entry is blocked, the monopolist can keep this super-normal profit in the long run
Explanation
Profit is the rectangle between price and AC at the output where MC = MR.