The Supply Curve of a Firm in the Short Run
The Short Run
The short run in economics refers to a period during which at least one factor of production is fixed. Typically, capital (such as machinery, buildings, and equipment) is considered fixed in the short run, while other inputs like labor and raw materials can be adjusted to meet changes in demand. The key characteristic of the short run is that firms cannot fully adjust their production capacity; they can only make limited changes to output by varying the variable inputs.
The Firm's Supply Curve in the Short Run
The short-run supply curve of a firm shows the relationship between the price of the good and the quantity of the good that the firm is willing to supply, given the fixed inputs. It is derived from the firm’s marginal cost curve above the average variable cost (AVC) curve. This is because, in the short run, a firm will only produce if it can cover its variable costs; otherwise, it will shut down.
Marginal Cost (MC): The additional cost of producing one more unit of output. The MC curve typically slopes upward due to the law of diminishing returns, which states that as more of a variable input is added to a fixed input, the additional output from each additional unit of input eventually decreases.
Average Variable Cost (AVC): The firm’s variable costs (e.g., labor, raw materials) divided by the quantity of output produced. The AVC curve also slopes upward but is generally flatter than the MC curve.
Example:
Consider a bakery that produces bread. In the short run, the bakery can hire more workers and purchase more ingredients (variable inputs) but cannot expand its kitchen size (fixed input). The bakery's short-run supply curve is determined by its marginal cost of producing additional loaves of bread. As the bakery increases production, each additional loaf becomes more expensive to produce due to the limited space in the kitchen, leading to an upward-sloping supply curve.
The Shut-Down Point
In the short run, a firm may continue operating even if it is not covering its total costs, as long as it covers its variable costs. The shut-down point occurs where the price equals the minimum average variable cost (AVC). If the market price falls below this point, the firm will shut down operations, as it cannot even cover its variable costs.
Graphical Representation:
- The MC curve intersects the AVC curve at its lowest point.
- The firm’s short-run supply curve is the portion of the MC curve that lies above the AVC curve.
The Supply Curve of an Industry in the Short Run
The short-run supply curve of an industry is the horizontal summation of the short-run supply curves of all the individual firms in the industry. This curve shows the total quantity of a good that all firms in the industry are willing to supply at different price levels, holding all other factors constant.
Industry Equilibrium in the Short Run
In the short run, industry equilibrium is determined by the intersection of the market demand curve and the industry supply curve. This determines the equilibrium price and total quantity supplied in the market.
- Market Supply Curve: The total quantity supplied by all firms at each price level.
- Market Demand Curve: The total quantity demanded by all consumers at each price level.
Example:
In the case of the bakery industry, the short-run industry supply curve is the sum of the supply curves of all bakeries. If there is an increase in demand for bread, the market price will rise, leading to an increase in the quantity supplied by each bakery. The new equilibrium is established where the increased demand intersects the industry supply curve.
Short-Run Equilibrium of the Firm and Industry
Short-Run Equilibrium of the Firm
In the short run, a firm is in equilibrium when it maximizes its profit, which occurs where marginal cost (MC) equals marginal revenue (MR). Marginal revenue is the additional revenue gained from selling one more unit of output. For a firm in a competitive market, MR equals the market price (P), so the equilibrium condition is:
At this point, the firm produces the quantity where its marginal cost of production equals the market price, and it adjusts output to maximize profits or minimize losses.
Profit or Loss:
- Profit: If the price is above the average total cost (ATC), the firm earns a profit.
- Break-even: If the price equals the ATC, the firm breaks even, earning zero economic profit.
- Loss: If the price is below the ATC but above the AVC, the firm incurs a loss but continues to operate because it covers its variable costs.
Short-Run Equilibrium of the Industry
In the short run, the industry equilibrium is determined by the intersection of the industry supply and demand curves. This equilibrium dictates the market price that individual firms take as given.
- Positive Economic Profit: If the price is above the ATC for most firms, firms are earning positive economic profits. This attracts new firms into the industry in the long run.
- Zero Economic Profit: If the price equals the ATC, firms are breaking even, earning zero economic profit. No new firms are attracted, and no firms exit.
- Negative Economic Profit: If the price is below the ATC but firms continue to cover their AVC, some firms incur losses, but they may continue operating in the short run.
Long-Run Equilibrium of the Firm and Industry
The Long Run
The long run is a period during which all factors of production are variable, and firms can fully adjust their production capacity. In the long run, firms can enter or exit the market, adjust their capital stock, and change the scale of their operations. The key characteristic of the long run is that there are no fixed inputs, and firms have the flexibility to optimize their production processes fully.
The Firm’s Supply Curve in the Long Run
In the long run, the firm’s supply curve is more elastic than in the short run because firms can adjust all inputs, including capital. The long-run supply curve is derived from the firm’s long-run marginal cost curve (LMC) and is typically flatter than the short-run supply curve.
- Long-Run Marginal Cost (LMC): The additional cost of producing one more unit of output when all inputs are variable.
- Long-Run Average Cost (LAC): The average cost of production when all inputs are variable. The LAC curve typically has a U-shape, reflecting economies and diseconomies of scale.
Long-Run Equilibrium of the Firm
In the long run, a firm is in equilibrium when it produces at the lowest point on its long-run average cost (LAC) curve, where LMC equals LAC and equals the market price (P). At this point, the firm is earning zero economic profit (normal profit), which is the typical outcome in a perfectly competitive market in the long run.
- Zero Economic Profit: In the long run, firms earn zero economic profit because any positive economic profit attracts new firms, increasing supply and driving down prices until profits are eroded. Conversely, if firms incur losses, some will exit the market, reducing supply and driving up prices until remaining firms break even.
Graphical Representation:
- The firm’s long-run supply curve is the portion of the LMC curve above the LAC curve’s minimum point.
- Long-run equilibrium occurs where the LMC curve intersects the LAC curve at its lowest point, and both equal the market price.
The Industry’s Long-Run Supply Curve
The long-run supply curve of an industry depends on the market structure and the behavior of firms:
- Increasing-Cost Industry: If input prices rise as the industry expands, the long-run supply curve slopes upward.
- Decreasing-Cost Industry: If input prices fall as the industry expands (due to economies of scale or improved technology), the long-run supply curve slopes downward.
- Constant-Cost Industry: If input prices remain constant as the industry expands, the long-run supply curve is horizontal.
Long-Run Equilibrium of the Industry
In the long run, the industry reaches equilibrium when firms are earning zero economic profit, and there is no incentive for new firms to enter or existing firms to exit the market. This occurs where the market price equals the minimum point on the long-run average cost curve for firms in the industry.
- Entry and Exit: In the long run, if firms are earning positive economic profits, new firms will enter the industry, increasing supply and driving down prices. If firms are incurring losses, some will exit the industry, reducing supply and driving up prices.
Consider the bakery industry. In the long run, if bakeries are earning positive profits due to high bread prices, new bakeries will enter the market, increasing the supply of bread and reducing prices.