Monopoly – Theory of The Firm

Monopoly Abnormal profit

The above diagram represents the existence of a monopoly, due to the abnormal profit shown. The firm operating at this point is profit maximizing, and abnormal profit means that they have more profit than they need to break-even at the point of normal profit.

Through this graph it can be noted that the firm is not a maximum productive efficiency, as the condition for a firm to at maximum productive efficiency would be to produce at the lowest point of average total cost.  It can be noted that the firm is operating just above the lowest point of average total cost. The reason this represents maximum productive efficiency is because all of the costs of the firm are being met by revenue generated by the sold products.

Furthermore, the firm is not operating at the point of maximum allocative efficiency. This can be identified through the fact that the price at the point of profit maximization is not equal to marginal cost. This lack of allocative efficiency represents a type of market failure (in this case the existence of monopoly), this is shown by the dead-weight loss which is the highlighted triangle in the graph.

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