In a market where perfect competition exists, firms only make normal profit. Profit margins are kept low because consumers would know absolutely about the price of all other companies' products, and as the products would be homogenous companies would have to compete on price. There would be just enough profit to keep firms in the industry (any less, and the profit-signalling mechanism would see it spirited away).

Of course, there's no such thing as perfect competition. And as soon as there's not perfect competition, super-normal profits can begin to appear. These are profits that are gained by either restricting output or controlling prices. This is more likely to occur the further away from perfect competition you get, with a monopolist most likely to be gaining super-normal profits.

Imagine a theoretical market where perfect competition exists, say it was for shoes. All the sellers in this market make white trainers. One seller starts making black trainers instead, and these are very popular with consumers. This firm will, for a time, make super-normal profits as they buy this product in preference to the standard item. This firm has a significant competitive advantage - but it will begin to be eroded as other firms catch on and begin to supply black trainers as well. Competition pushes down profits towards the level of normal profit.

Where super-normal profits exist, resources are not being allocated as efficiently as they could be. Perfect competition forces companies to become technically efficient to keep costs low so they can then keep prices low. If companies try and sell a product above the lowest possible cost, people will shop elsewhere and they'll go out of business.

Log in or registerto write something here or to contact authors.