IBonomicsAbnormal Profit from Collusion in OligopolyHL
MicroeconomicsA diagram showing how firms in an oligopoly can earn abnormal profit when they collude and behave like a monopoly.
Curves and elements
- AR = D
- The average revenue curve, which is also the market demand curve.
- MR
- The marginal revenue curve, which lies below the demand curve in imperfect competition.
- MC
- The marginal cost curve, showing the additional cost of producing one more unit.
- AC
- The average cost curve, showing cost per unit of output.
- Qm
- The profit-maximizing output under collusion, found where MC equals MR.
- Pm
- The collusive price charged at output Qm, found from the demand curve.
- Abnormal profit
- The shaded area between price and average cost at Qm, showing supernormal profit earned through collusion.
Key explanations
- 1
In collusion, firms cooperate rather than compete, often by agreeing on price or output.
- 2
When oligopolistic firms collude, they act like a monopoly and maximize joint profit by producing where marginal cost equals marginal revenue.
- 3
The collusive output is Qm, found where MC intersects MR, and the collusive price is Pm, found by projecting up to the demand curve.
- 4
Because average cost at Qm is lower than price, the firms earn abnormal profit.
- 5
The shaded area shows abnormal profit, equal to the difference between price and average cost multiplied by quantity sold.
Example exam question
Explain how collusion in an oligopoly can lead to abnormal profit, using a diagram.
Show example answer
When firms collude, they behave like a monopoly by producing where MC equals MR and then charging the price shown on the demand curve. If price is above average cost at that output, the firms earn abnormal profit shown by the shaded area.
