Before you can understand supernormal profit it is important that you understand normal profit.

Normal profit is the minimum level of profit necessary for a firm owner to keep their resources employed in their current use. So a firm owner that produces birthday cakes has a target business profit of £1000 per month then so long as the firm generates enough revenue to cover all costs and the £1000 business profit the firm owner will continue to use their factors of production to produce birthday cakes as normal profit is being made.

Supernormal profit is therefore anything above this amount. If the firm generates enough revenue to cover all the costs this month plus £1500 profit then the firm has made £500 supernormal profit.  This can also be referred to as abnormal profit.

Supernormal Profit in a Monopoly

A firm making a supernormal profit in a monopoly market

• This firm has price setting ability and can choose its output level.
• We assume that the firm will profit maximise and therefore the output (Q1) is drawn from where the MR curve cuts the MC curve.
• Extending this line up to the AR curve gives us the total revenue for the firm (P1,Q1).
• Then drawing a horizontal line from the intersection of Q1 and the ATC curve gives the costs associated with that level of output.
• Supernormal profit is then highlighted in blue.
• Firms in monopoly markets continue to make supernormal profits as barriers to entry are high and there is likely a large degree of information asymmetry

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Supernormal Profit in Perfect Competition

A firm making supernormal profit in a perfectly competitive market (short term)

• In markets with perfect competition it is only possible to make a profit in the short run. 
• In the example above the market diagram on the left dictates the price level which is then translated over to firm's costs and revenue diagram on the left.
• Firms in perfect competition are price takers meaning they have no price setting power.
• This causes the MR and AR to remain constant at P1 (D=MR=AR).
• The PC firm still profit maximise at output MR=MC

The next diagram shows how these supernormal profits are removed in the long run.

A firm making normal profit in a perfectly competitive market (long term)

• In the long run supernormal profits are removed from the market.
• Remember in perfectly competitive markets there are no barriers to entry or exit and perfect knowledge.
• As there are no barriers to entry firms outside the market see supernormal profits being made and enter the market which causes a shift in market supply from S1 to S2.
• The firm's cost revenue diagram now has a new D=MR=AR curve at a lower price which cuts through the lowest point of the ATC curve and therefore only normal profits are now being made.