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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 slide 1 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 slide 2 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 slide 3 We can show Average and Total Fixed Costs on the diagram. The next slide shows how. $/Q MC AC AFC = AC - AVC AVC Q Competitive markets in the short-run slide 4 Total fixed cost (FC) can be shown on the graph, and is, of course, that same at every output. $/Q FC if output is small MC AC AVC Q $/Q FC if output is larger MC AC AVC Q Equal areas at any output Competitive markets in the short-run slide 5 If price is greater than AVC, then the firm should produce where MC = MR. $/Q $/Q FC: Loss if Q = 0 Loss at MC=MR MC AC AVC Q Competitive markets in the short-run MC AC AVC Q slide 6 If price is less than AVC, then the firm should produce nothing and take a loss equal to FC. $/Q $/Q FC: Loss if Q = 0 Loss at MC=MR MC AC AVC Q Competitive markets in the short-run MC AC AVC Q slide 7 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 slide 8 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 slide 9 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 slide 10 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. Hidden slide Competitive markets in the short-run slide 11 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 slide 13 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 AC Q1=500q1 P1 P0 q0 q1 q2 Typical firm Competitive markets in the short-run q Q0 Q1 Q Q2 Industry slide 14 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 D q qE Typical firm Competitive markets in the short-run Q QE Industry slide 15 HERE ARE SOME APPLICATIONS OF THE SHORT-RUN MODEL OF COMPETITION Competitive markets in the short-run slide 16 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 slide 17 EQUILIBRIUM IN THE XMAS TREE MARKET IN THE SHORT-RUN. $/q $/Q S= MC MC=SRS AC pE D q qE Q QE Industry Typical firm XMAS TREE MARKET Competitive markets in the short-run Hidden slide slide 18 PROBLEM SUMMARY: A) B) C) D) Industry output increases. Price rises. The firm’s output rises. The firm’s profits rise. Competitive markets in the short-run slide 20 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 slide 21 EQUILIBRIUM IN THE PIZZA MARKET IN THE SHORT-RUN. $/q $/Q S= MC MC=SRS AC pE D q qE Typical firm Competitive markets in the short-run PIZZA MARKET Q QE Industry Hidden slide slide 22 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 slide 24 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 slide 25 EQUILIBRIUM IN THE BEER MARKET IN THE SHORT-RUN. $/q $/Q S= MC MC=SRS AC pE D q qE Typical firm Competitive markets in the short-run BEER MARKET Q QE Industry Hidden slide slide 26 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 slide 28 4) The pizza market is in equilibrium in the shortrun 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 slide 29 EQUILIBRIUM IN THE PIZZA MARKET IN THE SHORT-RUN. $/q $/Q S= MC MC AC pE D qE q Typical firm QE Industry PIZZA MARKET Competitive markets in the short-run Q Hidden slide slide 30 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 slide 32