Home > Economics FAQs Blogs > In a supernormal profit diagram, when demonstrating a transition from super normal to normal profit via a downward shift in the average revenue curve, is it also necessary to shift the marginal revenue curve?
This question pertains to topics in Microeconomics, such as Market Structures, Profit Maximization, and the behavior of firms.
1. Supernormal Profit:
Profit above the normal profit level. Normal profit is the minimum return needed to keep a firm operational.
2. Average Revenue (AR): Revenue generated per unit sold. In perfectly competitive markets, it equals the price of goods or services.
3. Marginal Revenue (MR): The additional revenue a firm gains from selling an additional unit.
4. Normal Profit: When a firm's total revenue equals its total cost, including opportunity costs.
In a perfectly competitive market, a firm's average revenue (AR) curve is also its demand curve.
This is because the price received per unit remains constant regardless of the number of units sold
. However, in imperfect markets (e.g., monopolies), the AR and MR curves are different due to the price discrimination effect.
In the case of a downward shift in the AR curve, it signifies a decrease in the price of the product. According to the relationship between AR and MR, a decrease in AR will also lead to a decrease in MR. This is because the MR curve is steeper than the AR curve due to the law of diminishing returns.
In a perfectly competitive market
, each firm is a price taker
, meaning it has no control over the price of the product it sells.
In such a case, the price remains constant regardless of the quantity sold. Therefore, AR
, which is equal to the price in this case, remains constant
. And since each additional unit sold fetches the same price, the MR also remains constant and equal to AR (price).
In an imperfect market, such as a monopoly or monopolistic competition, the firm is a price maker. It has some control over the price of its product. In such a market, the demand curve, which is also the firm's AR curve, slopes downward. This is because to sell more units, the firm must lower the price.
Because the price decreases with each additional unit sold, MR in an imperfect market is less than AR. This results from the fact that not only does the next unit sell for less, but all previous units must also be sold for less to increase sales. Hence, the MR curve lies below the AR curve.
Therefore, in both market types, AR and MR are closely related, and changes in AR often lead to changes in MR. In a perfectly competitive market, a change in price will shift both AR and MR equally. In an imperfect market, a decrease in AR (price) will lead to a decrease in MR, but MR decreases at a faster rate, which leads to a steeper MR curve.
So, if there's a downward shift in the AR curve (i.e., a decrease in price), the MR curve also shifts downward, reflecting the reduced revenue from each additional unit sold. In a profit diagram, this downward shift could potentially move a firm from a state of supernormal profits to normal profits, as the price (AR) could become equal to the average total cost (ATC) at the profit-maximizing output level.
In the transition from supernormal to normal profit, it is necessary for both the AR and MR curves to shift downwards as they are inherently related. In this case, the downward shift led to a reduction in profit per unit, moving the firm from a state of supernormal profit to normal profit.