Normal Profit: Perfect and Imperfect Competition

What this diagram shows

Demand, MR and MC are the same as in the supernormal profit and loss diagrams; only average cost has changed. Higher fixed costs raise AC at every output without moving MC, so each firm still produces q₁ where MC = MR and charges the same price. At q₁ price now equals average cost, AR = AC, so total revenue just covers total cost, including the opportunity cost of the owners' capital and effort: the firm makes normal profit. For the price taker this happens at the minimum of AC. For the imperfectly competitive firm the downward-sloping demand curve just touches AC on its falling part, to the left of minimum AC.

Key points

• Normal profit occurs where AR = AC at the profit-maximising output, where MC = MR.
• Normal profit is the minimum return needed to keep the owners' capital and effort in the business. It is an opportunity cost, so it is included in AC.
• In perfect competition the horizontal D = AR = MR line touches AC at its minimum, so P = MC = AC.
• In imperfect competition the downward-sloping AR just touches AC on its falling part, at the output where MR = MC, so q₁ is below the output at which AC is lowest.
• Fixed costs do not affect MC, so q₁ and the price are the same as in the supernormal profit and loss diagrams; only the height of AC differs.