It can be argued that there is no firm that is really a monopoly because true monopoly exists when there is only one producer of a commodity that has no close substitute. However, it can be said that monopoly exists when one firm dominates a market. The demand curve is downward sloping and the monopoly firm is the price taker. Monopolies are caused by economies of scale (can create natural monopolies) and a firm controlling an essential factor of production. (can create artificial monopolies).
Monopolies that are able to make supernormal profits, are not necessarily against the public interest, in fact, almost all, if not all profit based organization; aim to make as much profit as it can at any given time. i.e. maximise profit. The fact that monopolies which make supernormal profits could charge lower prices does not necessarily indicate that they can afford to charge lower prices for goods and or services offered to the public.
Perfect competition model and monopoly model will be used to show how supernormal profits are acquired by firms. Topics such as benefits and consequence of supernormal profits ( short and long run benefits of supernormal profits to a firm) , types of supernormal profits by firms, concept of supernormal profits in relation to consumer or public interest and efficiency and ways which firms make supernormal profits will be used to explain why monopoly firms are not necessarily against the public interest in regards to prices they charge for their products.
Supernormal profits are profits made in excess of normal profits i.e. excess profit made over the normal profit, while normal profit is the amount of money made by an organization that is just enough to cover its expenses and not go bust. Supernormal profits can be in the long run or in the short run. Not all firms make supernormal profits in the short run. Firms that make supernormal profits in any market are giving indications that the market is viable and that there is an opportunity for money to be made. These prompts new suppliers into the market and the theory of demand and supply play a major role in influencing how the supernormal profits are competed away. However, how fast the supernormal profit is competed away depends on the barriers to entry in the market or industry.
In a situation where perfect competition exists, there is optimum allocation of resources. Perfect competition is currently deemed as theoretical market and is based on some assumptions before it can exist in an industry. These assumptions are that : there must be no barriers to entry , there must be perfect knowledge of the market , there must be large amount of buyers and suppliers that neither can easily influence the market price , there must be homogeneous goods and low transport costs .However, supernormal profits can still be made by an individual firm in the short run. This could be as a result of a new innovation or new idea.
These assumptions in the perfect competition show that the consumer benefits because Average revenue equals Marginal revenue equals average total cost hence only normal profit is made. That is P=MR=AR .
Monopolistic competition, on the other hand, is a situation whereby there are many small firms that produce differentiated products and the price and output decisions of any of the firms can have no effect on the out put and decision of other firms. In a monopolistic competition, firms usually charge supernormal profits because demand is inelastic .This income (supernormal profits) is siphoned and redistributed usually to the shareholders. This means that if there are supernormal profits, there is also productive and allocative inefficiency. In the short run equilibrium in a monopolistic competition there can be supernormal profits but quickly competed away in the long run due to easy market entry into the monopolistic competitive market.
A competitor and a monopolist have one thing in common and it is to maximize profits. They both have similar attributes except they operate in 2 different market systems. As we can see in the monopoly model, the marginal cost curve is not the same as it is in the perfect competition model, the demand curve shows he highest possible price that can be charged to a product at a given level of output. In this way, the monopolists can make supernormal profits by setting output level at Marginal Cost equals Marginal Revenue i.e. MC = MR and setting price for the product by choosing the point that intersects the demand curve and the vertical line drawn through the point where MC=MR.
For a perfect competitor, the price will always be equal to the marginal revenue , but for a monopolist the price will always be greater than the marginal cost. When a monopolist is making a normal profit , it doesn’t necessarily mean that it has to be at the lowest point of the average cost curve.
Allocative efficiency is also known as Pareto efficiency and is based on the work of an Italian economist called Vilfredo Pareto . This particular work is called Manuel D’Economie Politique ( 1909 ). Allocative efficiency means that it is possible to improve one consumers welfare without making another consumer worse off. In order words , resources are allocated efficiently so that the welfare of a group of consumers are improved without making another group of consumers worse off in the economy.
Productive efficiency means production of goods and services at a minimum cost. This means it is not possible to produce more of any particular good without producing less of another. This means that there is no waste in the production process.
In a monopolistic competition, if both the allocative and productive efficiency are applied the consumers will be charged less and the monopoly firm will be making only a normal profit but the price charged will be higher than the marginal cost. This normal profit can either be used to maximize profits or to minimize competition .The demand curve plays a major role in determining output levels. However, monopolies have its downside such as allocative inefficiency, price discrimination cartels, artificial scarcities and productive/technological inefficiency.
Monopolistic firms also make supernormal profits by differentiating their products more from rival products and this could be through adverts or by just changing the product a bit. Another way for monopolistic firms to make supernormal profits is by having a overall cost leadership.
Perfect competition is an ideal model , but it doesn’t really exist, for example share prices are decided by almost competitive markets. There have been criticisms against perfect competition and monopolistic competition. Perfect competition is good for customers because they will be getting goods at the least prices . This appeals to the public interest while monopoly is deemed as bad because goods are identical, produce less and consumers pay more than they should for goods and services when compared with perfect competitive market.
In the case of drug companies ( largely monopolies ), supernormal profits are needed so that the drug firm can spend more on its researching and developing to develop more medicines to help improve lifestyle. Other large firms are also able to develop new products that could bring more technological advancement, pay high staff salaries , give pay rise and bonuses due to the supernormal profits they make.
Shareholders always want high returns at all times and these increasing returns can only come from supernormal profits. An employee in a firm that is in a highly competitive market , will always be on the edge because he or she could lose their job anytime , an employee would like to be employed by a company that is well off rather than a firm that is always on the edge of break even.
In conclusion, it can be seen that monopolies are not necessarily against public interest because some supernormal profits are used to improve products the firms make and the public benefit from these research and development while some do go to shareholders.
Monopolies make supernormal profits in the short run but are quickly competed away in the long run by new entrants into the market due to easy entry barrier. Perfect competition is ideal because Marginal Revenue equals Marginal Cost, no abnormal profits, just normal profits but could deter future developments while monopolies will always have the price of their products higher than the marginal cost because when Marginal cost equals Marginal revenue profit is maximized.