1. COMPETITIVE MARKET (INDUSTRY) SUPPLY

2. Supply From A Competitive Industry
How are the supply decisions of the many individual firms in a competitive industry to be combined to discover the market supply curve for the entire industry?

3. Supply From A Competitive Industry
Since every firm in the industry is a price-taker, total quantity supplied at a given price is the sum of quantities supplied at that price by the individual firms.

4. Short-Run Supply
In a short-run the number of firms in the industry is, temporarily, fixed.
Let n be the number of firms; i = 1, … ,n.
Si(p) is firm i’s supply function.
The industry’s short-run supply function is

5. Supply From A Competitive Industry
S1(p)
S2(p)
Firm 1’s Supply
Firm 2’s Supply

6. Supply From A Competitive Industry
Firm 1’s Supply
Firm 2’s Supply p p p’
S1(p’)
S1(p)
S2(p) p p’
S1(p’)
S(p) = S1(p) + S2(p)
Industry’s Supply

7. Supply From A Competitive Industry
Firm 1’s Supply
Firm 2’s Supply p p p”
S1(p”)
S1(p)
S2(p”)
S2(p) p p”
S1(p”)+S2(p”)
S(p) = S1(p) + S2(p)
Industry’s Supply

8. Supply From A Competitive Industry
Firm 1’s Supply
Firm 2’s Supply p p
S1(p)
S2(p) p
S(p) = S1(p) + S2(p)
Industry’s Supply

9. Short-Run Industry Equilibrium
In a short-run, neither entry nor exit can occur.
Consequently, in a short-run equilibrium, some firms may earn positive economics profits, others may suffer economic losses, and still others may earn zero economic profit.

10. Short-Run Industry Equilibrium
Short-run industry supply
pse
Market demand
Qse Q
Short-run equilibrium price clears the market and is taken as given by each firm.

11. Long-Run Industry Supply
In the long-run every firm now in the industry is free to exit and firms now outside the industry are free to enter (i.e. different than the Short-Run, number of firms will vary in the Long-Run).
The industry’s long-run supply function must account for entry and exit as well as for the supply choices of firms that choose to be in the industry.
Horizontal Summation of individual firm’s long-run supply will not help to determine the long-run industry supply since number of firms will not be fixed.

12. Long-Run Industry Supply
How is this done? (We need LR equilibrium definition to derive Long-Run Industry Supply)
DEFINITION: Long-Run equilibrium will occur where there will be no more entry and exit.
For simplicity, assume that the firm’s have the same cost curves. Let’s derive the LR Industry Supply.

13. Long-Run Industry Equilibrium
Positive economic profit induces entry.
Economic profit is positive when the market price pse is higher than a firm’s minimum av. total cost; pse > min AC(y).
Entry increases industry supply, causing pse to fall.
When does entry cease?

14. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S2(p)
Mkt. Supply q Q
Suppose the industry initially contains only two firms.

15. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S2(p) p2 p2 q Q
Then the market-clearing price is p2.

16. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S2(p) p2 p2
q2* q Q
Then the market-clearing price is p2. Each firm produces q2* units of output.

17. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S2(p) p2 p2
P > 0
q2* q Q
Each firm makes a positive economic profit, inducing entry by another firm.

18. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S2(p)
S3(p) p2 p2
q2* q Q
Market supply shifts outwards.

19. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S2(p)
S3(p) p2 p2
q2* q Q
Market supply shifts outwards. Market price falls.

20. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S2(p)
S3(p) p3 p3
q3* q Q
Each firm produces less.

21. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S2(p)
S3(p) p3 p3
P > 0
q3* q Q
Each firm produces less. Each firm’s economic profit is reduced.

22. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S3(p) p3 p3
P > 0
q3* q Q
Each firm’s economic profit is positive. Will another firm enter?

23. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S3(p)
S4(p) p3 p3
q3* q Q
Market supply would shift outwards again.

24. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S3(p)
S4(p) p3 p3
q3* q Q
Market supply would shift outwards again. Market price would fall again.

25. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S3(p)
S4(p) p4 p4
q4* q Q
Each firm would produce less again.

26. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S3(p)
S4(p) p4 p4
P < 0
q4* q Q
Each firm would produce less again. Each firm’s economic profit would be negative.

27. Long-Run Industry Equilibrium
The Market
A “Typical” Firm p p
Mkt. Demand
MC(q)
AC(q)
S3(p)
S4(p) p4 p4
P < 0
q4* q Q
Each firm would produce less again. Each firm’s economic profit would be negative. So the fourth firm would not enter.

28. Long-Run Industry Equilibrium
The long-run number of firms in the industry is the largest number for which the market price is at least as large as min AC(y)
In the long-run market equilibrium, the market price is determined solely by the long-run minimum average cost Long-run market price is

29. Long-Run Industry Supply
With identical cost firms, free entry and exit, the LR market supply curve is flat at the minimum Long-Run AC.