competitive supply

Competitive markets in the short-run slide 1

COMPETITIVE SUPPLYCOMPETITIVE SUPPLYIN THIS SECTION WE WILL DERIVE THE

COMPETITIVE FIRM’S SUPPLY CURVE.

THEN WE’LL ADD TOGETHER THE SUPPLY CURVES OF THE FIRMS TO GET THE MARKET SUPPLY CURVE OF A GOOD.

FINALLY, WE’LL SHOW HOW MARKET PRICES ARE DETERMINED IN COMPETITIVE MARKETS.


THE SUPPLY CURVE OF A COMPETITIVE FIRM CORRESPONDS ALMOST EXACTLY TO ITS MARGINAL COST CURVE.

[Recall that a supply curve tells you how much will be desired to be sold at each price. The game here is to choose several prices, then and see how much the firm wants to sell at each price.]


To find a firm's supply curve we need to review the ideas of AVERAGE COST, and AVERAGE VARIABLE COST.

What do the AC and AVC curves look like for a competitive firm?


We can show Average and Total Fixed Costs on the diagram. The next slide shows how.

$/Q

AC

AVC

MC

Q

AFC = AC - AVC


Total fixed cost (FC) can be shown on the graph, and is, of course, that same at every output.

FC if output is small FC if output is larger$/Q

AC

AVC

MC

Q Q

AVC

MC

AC

$/Q

Equal areas at any output


If price is greater than AVC, then the firm should produce where MC = MR.

Loss at MC=MR

FC: Loss if Q = 0$/Q

AC

AVC

MC

Q Q

AVC

MC

AC

$/Q


If price is less than AVC, then the firm should produce nothing and take a loss equal to FC.

$/Q

AC

AVC

MC

Q Q

AVC

MC

AC

$/Q

Loss at MC=MR

FC: Loss if Q = 0


If a firm cannot cover its variable costs, it should shut down, and take a loss equal to fixed cost.

If a firm’s revenue is greater than variable costs, it should produce where MC = MR, even if that means taking a loss.


Supply curve of a competitive firm:

The curve that shows for each level of output price the quantity supplied by the firm.

ONE POINT OF THIS IS THAT WE CAN NOW FIND THE SUPPLY CURVE OF AN INDIVIDUAL COMPETITIVE FIRM.


In the short-run, a competitive firm’s supply curve is its marginal cost curve above average variable cost.

Economists sometimes say “Marginal cost curves are supply curves.” This is almost true. The exception is the part of a marginal cost curve that lies below AVC.


The next (hidden slide) shows the derivation of the firm's short-run supply curve.

The firm's SR supply curve is its marginal cost curve above average variable cost.


Finding the industry supply curve

There are many firms in a perfectly competitive industry.

We can find the industry or market supply curve by adding together the quantities supplied by all firms at each market price.


AC

Typical firm Industry

$/Q$/q

q Q

MC=SRS S= MC

IF THERE ARE 500 FIRMS IN THE INDUSTRY, THE MARKET SUPPLY CURVE CAN BE FOUND BY ADDINGTOGETHER THE SUPPLY OF THE FIRMS AT EACH PRICE.

P0

q0

P1

q1

P2

q2 Q0 Q1

Q1=500q1Q1=500q1

Q2


AC


$/Q$/q

q Q

MC=SRS

D

S= MC

EQUILIBRIUM IN THE SHORT-RUN FOR A FIRMAND INDUSTRY IN PERFECT COMPETITION.

pE

qEQE

BY INCLUDING THE MARKET DEMAND CURVE WE CANFIND THE MARKET CLEARING PRICE.


HERE ARE SOME HERE ARE SOME APPLICATIONS OF THE APPLICATIONS OF THE SHORT-RUN MODEL OF SHORT-RUN MODEL OF

COMPETITIONCOMPETITION


1) Suppose the perfectly competitive market for Xmas trees is in short-run equilibrium. There is an increase in demand for Xmas trees. What is the effect on the market price and quantity of trees, and on the quantity and profits of the typical firm?


AC


$/Q$/q

q Q

MC=SRS

D

S= MC

EQUILIBRIUM IN THE XMAS TREE MARKET IN THE SHORT-RUN.

pE

qE QE

XMAS TREE MARKET Hidden slide


PROBLEM SUMMARY:

A) Industry output increases.

B) Price rises.

C) The firm’s output rises.

D) The firm’s profits rise.


2) Suppose the perfectly competitive market for pizza is in short-run equilibrium. There is an increase in the price of tomato sauce, an ingredient of pizza. What is the effect on the market price and quantity of pizza, and on the quantity and profits of the typical firm?


AC


$/Q$/q

q Q

MC=SRS

D

S= MC

EQUILIBRIUM IN THE PIZZA MARKET IN THE SHORT-RUN.

pE

qEQE

PIZZA MARKETHidden slide


SUMMARY:

The increase in the price of an input raises both average costs and marginal costs for all of the firms.

Therefore all firms want to supply less than before at the going market price.

Excess demand causes price to rise, but price cannot rise by as much as costs rose, so profits will fall.


3) There is an improvement in the technology in the beer industry. What is the short-run effect on the typical firm and industry if the industry is perfectly competitive?


AC


$/Q$/q

q Q

MC=SRS

D

S= MC

EQUILIBRIUM IN THE BEER MARKET IN THE SHORT-RUN.

pE

qEQE

BEER MARKETHidden slide


SUMMARY:

The improvement in technology lowers both average costs and marginal costs for all of the firms.

Therefore all firms want to supply more than before at the going market price.

Excess supply causes price to fall.


4) The pizza market is in equilibrium in the short-run at a price of $10 per pizza. The government decides to impose a tax of $2 per pizza on all pizzas sold. What is the short-run effect of the tax on the price of pizza, quantity of pizzas for the firm and industry, and on the profits of the typical firm?


AC


$/Q$/q

q Q

MC

D

S= MC

EQUILIBRIUM IN THE PIZZA MARKET IN THE SHORT-RUN.

pE

qE QE

PIZZA MARKET Hidden slide


SUMMARY:

THE FIRMS’ MC CURVES AND THE MARKET SUPPLY CURVE RISE BY $2.

IN THE NEW EQUILIBRIUM, MARKET QUANTITY IS LESS, FIRM QUANTITY IS LESS, PRICE IS HIGHER (BUT BY LESS THAN $2), AND PROFITS ARE LESS.

competitive supply

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