COMPETITIVE SUPPLY IN 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. Competitive markets in the short-run

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.] Competitive markets in the short-run

What do the AC and AVC curves look like for a competitive firm? 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? Competitive markets in the short-run

We can show Average and Total Fixed Costs on the diagram We can show Average and Total Fixed Costs on the diagram. The next slide shows how. $/Q MC AFC = AC - AVC AC AVC Q Competitive markets in the short-run

Equal areas at any output 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 $/Q MC MC AC AC AVC AVC Equal areas at any output Q Q Competitive markets in the short-run

If price is greater than AVC, then the firm should produce where MC = MR. FC: Loss if Q = 0 $/Q $/Q Loss at MC=MR MC MC AC AC AVC AVC Q Q Competitive markets in the short-run

If price is less than AVC, then the firm should produce nothing and take a loss equal to FC. FC: Loss if Q = 0 Loss at MC=MR MC MC AC AC AVC AVC Q Q Competitive markets in the short-run

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. Competitive markets in the short-run

ONE POINT OF THIS IS THAT WE CAN NOW FIND THE SUPPLY CURVE OF AN INDIVIDUAL COMPETITIVE FIRM. Supply curve of a competitive firm: The curve that shows for each level of output price the quantity supplied by the firm. Competitive markets in the short-run

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. Competitive markets in the short-run

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. Competitive markets in the short-run

Tracing out the firm's supply curve at different prices. What's supply at these prices? SR supply $/Q $/Q MC MC AC AC AVC AVC Q Q Competitive markets in the short-run

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. Competitive markets in the short-run

$/q $/Q S= MC MC=SRS AC q Q IF THERE ARE 500 FIRMS IN THE INDUSTRY, THE MARKET SUPPLY CURVE CAN BE FOUND BY ADDING TOGETHER THE SUPPLY OF THE FIRMS AT EACH PRICE. $/q $/Q S= MC MC=SRS P2 q2 Q2 AC Q1 Q1=500q1 P1 q1 P0 q0 Q0 q Q Typical firm Industry Competitive markets in the short-run

$/q $/Q S= MC MC=SRS AC pE qE QE D q Q EQUILIBRIUM IN THE SHORT-RUN FOR A FIRM AND INDUSTRY IN PERFECT COMPETITION. BY INCLUDING THE MARKET DEMAND CURVE WE CAN FIND THE MARKET CLEARING PRICE. $/q $/Q S= MC MC=SRS AC pE qE QE D q Q Typical firm Industry Competitive markets in the short-run

HERE ARE SOME APPLICATIONS OF THE SHORT-RUN MODEL OF COMPETITION Competitive markets in the short-run

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? Competitive markets in the short-run

EQUILIBRIUM IN THE XMAS TREE MARKET IN THE SHORT-RUN. MC=SRS S= MC AC pE D q Q qE QE Industry Typical firm Hidden slide XMAS TREE MARKET Competitive markets in the short-run

AT THE OLD EQUILIBRIUM PRICE (pE) THERE IS EXCESS DEMAND INCREASES. AT THE OLD EQUILIBRIUM PRICE (pE) THERE IS EXCESS DEMAND AND PRICE RISES. $/q $/Q MC=SRS S= MC pE' AC qE' pE D’ D q Q QE qE Typical firm Industry Competitive markets in the short-run

A) Industry output increases. B) Price rises. PROBLEM SUMMARY: A) Industry output increases. B) Price rises. C) The firm’s output rises. D) The firm’s profits rise. Competitive markets in the short-run

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? Competitive markets in the short-run

EQUILIBRIUM IN THE PIZZA MARKET IN THE SHORT-RUN. MC=SRS S= MC AC pE D q Q QE qE Typical firm Industry PIZZA MARKET Hidden slide Competitive markets in the short-run

Costs rise. Typical firm Industry PIZZA MARKET S(NEW) MC(NEW) AC(NEW) $/q $/Q S= MC MC p(new) pE q(new) Q(new) AC D q Q qE QE Typical firm Industry PIZZA MARKET Competitive markets in the short-run

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. Competitive markets in the short-run

3) There is an improvement in the technology in the beer industry 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? Competitive markets in the short-run

EQUILIBRIUM IN THE BEER MARKET IN THE SHORT-RUN. MC=SRS S= MC AC pE D q Q QE qE Typical firm Industry BEER MARKET Hidden slide Competitive markets in the short-run

The improvement in technology lowers average and marginal costs. Firms can increase profit by selling more. In the new short-run equilibrium price will be lower and quantity higher for both the firm and industry. qE(new) QE(new) $/q $/Q MC S= MC AC(NEW) MC(NEW) S(NEW) AC pE D q Q QE qE Typical firm Industry BEER INDUSTRY Competitive markets in the short-run

Excess supply causes price to fall. 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. Competitive markets in the short-run

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? Competitive markets in the short-run

EQUILIBRIUM IN THE PIZZA MARKET IN THE SHORT-RUN. MC S= MC AC pE D q Q qE QE Typical firm Industry PIZZA MARKET Hidden slide Competitive markets in the short-run

THE EQUILIBRIUM PRICE RISES (BUT BY LESS THAN $2), AND QUANTITY FALLS FOR BOTH THE FIRM AND INDUSTRY. THE $2 TAX RAISES MC AND AC BY $2. MC + 2 AC + 2 S + tax $/q $/Q S MC p(new) Q(new) AC q(new) pE=10 D q Q QE qE Typical firm Industry PIZZA MARKET Competitive markets in the short-run

THE FIRMS’ MC CURVES AND THE MARKET SUPPLY CURVE RISE BY $2. 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 markets in the short-run