1. 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

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. $/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

15. $/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

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

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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

28. 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

29. 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

30. 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

31. 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

32. 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