Supernormal Profit: Perfect and Imperfect Competition

What this diagram shows

This is the first of three diagrams in which demand, MR and MC stay exactly the same and only average cost changes. Both firms maximise profit where MC = MR, at q₁ on the rising part of MC, and read the price from their demand (AR) curve at q₁. The price taker's demand curve is horizontal, so D = AR = MR; the imperfect competitor's AR slopes downwards, so its MR lies below AR, with the same intercept and twice the slope. Here fixed costs are low, so AC is low: price is above AC at q₁ and each firm makes supernormal profit, shown by the shaded rectangle (AR − AC) × q₁.

Key points

• Both firms maximise profit where MC = MR, at output q₁ on the rising part of the MC curve.
• The price is read from the AR (demand) curve directly above q₁, not from the point where MC = MR.
• In perfect competition the firm is a price taker, so its demand curve is horizontal and P = AR = MR. In imperfect competition AR slopes downwards and MR lies below it.
• Supernormal profit = (AR − AC) × q₁, using AC at q₁, not the minimum of AC.
• Fixed costs do not affect MC, so they do not change q₁ or the price. Low fixed costs simply give a low AC curve and a large profit rectangle.