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

Show on a plat how a monopoly firm volition make paranormal lettuces by restricting output. Discuss how the theory of contestable market places could impress on the wrong 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 perseverance without facing competition because of game barriers to entry to the exertion. The monopoliser is a short ravel out profit maximiser and collect to the demand under a monopoly cosmos 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 at a lower place shows the monopoly making supranormal profits by restricting output. The equilibrium profit maximising take aim 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 monopol y, it might develop at the bottom of its average cost curve (AC). Thus, price being lower than P and quantity produced would be greater. However, because a monopoly is partly delineate by wanting to profit maximise in the short run, this is not the case. C AC Price Quantity mR p A crave 0 Under perfect competition, supernormal profits can single if be made in the short run, due to low barriers to entry. The monopolist can seduce supernormal profit in the short and languish run due to not having to produce at the bottom of the AC curve and having high barriers to entry. These barriers to entry, proscribeing other potential rude(a) entrance from all overture 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 leaf blade committedness 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 entry will wee supernormal profits for a monopoly. Contestable market theory, in which states that in that location is freedom of entry to the industry and where be of exit are low, suggests that a monopoly will earn supernormal profits dependent to a astronomical extent on the costs of exit from the industry.If the costs of exit from the industry are low, then the monopoly arguably wont make supernormal profits in the long run. If a monopoly in the short run is charging high prices and earning supernormal profit, a challenger will enter the industry and take some market share from the monopolist by charging a lower price. The monopolist will react by reduction prices, forcing the new competitor out of the industry. This happens because the competitor cannot compete with the new lower prices get by the monopolist due to its costs being too high.Thus, if the costs of exit from the industry are low, it is wort h the competitor entering the market and having earned supernormal profits in the short run. Though, once the competitor has left the industry and the monopolist raises its price again wanting to earn supernormal profits, another competitor will enter the industry reducing the monopolists overall profits and taking market share away from it. clear the only way to avoid potential competitors from adopting hit and run tactics would be for the monopolist to price at a direct where it only earned normal profits.In the long run the monopolist will increase output and decrease price, operating at the optimal level of output where MC = AC. Thus in conclusion it has been shown that a monopoly will make supernormal profits by restricting output. The monopoly chooses the output level to produce at, and wanting to profit maximise, it produces at the point where marginal costs equals marginal revenue. In contestable market theory, the established firm, the monopoly, must stick out as if it operates in a perfectly competitive market to prevent hit and run tactics by potential competitors, producing where MC = AC.