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Firm Supply
Demand Curve Facing
Competitive Firm
Supply Decision of a
Competitive Firm
Producer’s Surplus
and Profits
Long-Run
The Demand Curve Facing a
Competitive Firm
p
market
price
p
*
0
y
Supply Decision of a
Competitive Firm
Problem of a competitive firm:
max py  c( y)
y
Revenues, Costs, and Profits
py
p
( y)
c( y )
y
Maximum Profits
py
p
c( y )
y
*
y
Optimal Quantity Supplied
Firm maximizes:
max py  c( y)
y
Necessary condition for optimal choice:
c( y )
p
 MC ( y )
y
An Example
Short-run cost function:
c y   y  1
2
Marginal cost function:
MC  y   2 y
An Example
Average variable costs:
2
y
AVC y  
y
y
Average costs:
2
y
1
1
AC y  
  y
y y
y
An Example
Profit maximization:
max py   y  1
2
y
Necessary condition:
p  2y
An Example
p
AC
MC
AVC
2
0
1
y
An Example: Profits
p
AC
p
MC
AVC
*
*
AC ( y )
*
AVC( y )
0
y
*
y
Producer’s Surplus
Producer’s surplus=Area below price above
supply curve
Alternatively:
py 
*
below supply curve
where area below supply curve (MC):
*
cv ( y )
An Example: Producer’s Surplus
p
AC
p
MC
AVC
*
0
y
*
y
An Example: Producer’s Surplus
p
AC
p
MC
AVC
*
AVC( y * )
0
y
*
y
Producer’s Surplus and Profits
Producer’s surplus:
py  cv ( y )
*
*
Profits:
py  cv ( y )  F
*
*
An Example: Producer’s Surplus
and Profits
p
AC
p
MC
AVC
*
*
AC ( y )
*
AVC( y )
0
y
*
y
An Example
Output:
*
p
y 
2
*
Profits:

  py  y
*
*2

p
 1 
* 2
4
1
An Example
Profits:

p

* 2
4
Producer’s surplus:
1
1 *  p  p 
p   
2  2 
4
*
* 2
One Exception: y1 or y 2 ?
MC
AC, MC , AVC
AC
AVC
p*
y1
y2
y
A Second Exception: Shutdown!
Profits if firm produces:
  py  cv ( y )  F
*
*
Profits if firm does not produce:
  F
Producing is better if:
py  cv ( y )  0
*
*
A Second Exception: Shutdown!
Producing is better if:
py  cv ( y )  0
*
*
Rearrange. Produce only if:
*
cv ( y )
p
*
y
Shutdown
MC
AC, MC , AVC
AC
AVC
p
*
y
*
y
The Firm’s Supply Curve
AC, MC , AVC
MC
AC
AVC
0
y
Long and Short Run Supply in
Consultant Firm Example
MC S ( y )
MC ( y )
p***
p
0
MC L ( y )
91 y
L
**
yS
**
y
Shutdown in the Short-Run and
in the Long-Run
In the short-run, the shutdown condition is:
*
cv ( y )
*
p
 AVC( y )
*
y
In the long-run, the shutdown condition is:
*
c( y )
*
p  *  AC ( y )
y