Competitive markets in the short-runslide 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-runslide 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-runslide 3 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-runslide 4 We can show Average and Total Fixed Costs on the diagram. The next slide shows how. $/Q AC AVC MC Q AFC = AC - AVC

Competitive markets in the short-runslide 5 Total fixed cost (FC) can be shown on the graph, and is, of course, that same at every output. FC if output is smallFC if output is larger $/Q AC AVC MC Q Q AVC MC AC $/Q Equal areas at any output

Competitive markets in the short-runslide 6 If price is greater than AVC, then the firm should produce where MC = MR. Loss at MC=MRFC: Loss if Q = 0 $/Q AC AVC MC Q Q AVC MC AC $/Q

Competitive markets in the short-runslide 7 If price is less than AVC, then the firm should produce nothing and take a loss equal to FC. $/Q AC AVC MC Q Q AVC MC AC $/Q Loss at MC=MRFC: Loss if Q = 0

Competitive markets in the short-runslide 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-runslide 9 Supply curve of a competitive firm: The curve that shows for each level of output price the quantity supplied by the firm. ONE POINT OF THIS IS THAT WE CAN NOW FIND THE SUPPLY CURVE OF AN INDIVIDUAL COMPETITIVE FIRM.

Competitive markets in the short-runslide 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-runslide 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. Hidden slide

Competitive markets in the short-runslide 12 Tracing out the firm's supply curve at different prices. $/Q AC AVC MC Q Q AVC MC AC $/Q SR supply What's supply at these prices?

Competitive markets in the short-runslide 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-runslide 14 AC Typical firmIndustry $/Q$/q qQ MC=SRS S=  MC 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. P0P0 q0q0 P1P1 q1q1 P2P2 q2q2 Q0Q0 Q1Q1 Q 1 =500q 1 Q2Q2

Competitive markets in the short-runslide 15 AC Typical firmIndustry $/Q$/q qQ MC=SRS D S=  MC EQUILIBRIUM IN THE SHORT-RUN FOR A FIRM AND INDUSTRY IN PERFECT COMPETITION. pEpE qEqE QEQE BY INCLUDING THE MARKET DEMAND CURVE WE CAN FIND THE MARKET CLEARING PRICE.

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

Competitive markets in the short-runslide 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-runslide 18 AC Typical firm Industry $/Q$/q qQ MC=SRS D S=  MC EQUILIBRIUM IN THE XMAS TREE MARKET IN THE SHORT-RUN. pEpE qEqE QEQE XMAS TREE MARKET Hidden slide

Competitive markets in the short-runslide 19 AC Typical firmIndustry $/Q$/q qQ MC=SRS D S=  MC AT THE OLD EQUILIBRIUM PRICE (p E ) THERE IS EXCESS DEMAND AND PRICE RISES. pEpE qEqE QEQE D’ DEMAND INCREASES. pE'pE' qE'qE'

Competitive markets in the short-runslide 20 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-runslide 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-runslide 22 AC Typical firmIndustry $/Q$/q qQ MC=SRS D S=  MC EQUILIBRIUM IN THE PIZZA MARKET IN THE SHORT-RUN. pEpE qEqE QEQE PIZZA MARKET Hidden slide

Competitive markets in the short-runslide 23 AC Typical firmIndustry $/Q$/q qQ MC D S=  MC pEpE qEqE QEQE q(new) Q(new) S(NEW) MC(NEW) AC(NEW) PIZZA MARKET p(new) Costs rise.

Competitive markets in the short-runslide 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-runslide 25 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-runslide 26 AC Typical firmIndustry $/Q$/q qQ MC=SRS D S=  MC EQUILIBRIUM IN THE BEER MARKET IN THE SHORT-RUN. pEpE qEqE QEQE BEER MARKET Hidden slide

Competitive markets in the short-runslide 27 AC Typical firm Industry $/Q$/q qQ MC D S=  MC pEpE qEqE QEQE BEER INDUSTRY AC(NEW) MC(NEW) S(NEW) In the new short-run equilibrium price will be lower and quantity higher for both the firm and industry. q E (new)Q E (new) The improvement in technology lowers average and marginal costs. Firms can increase profit by selling more.

Competitive markets in the short-runslide 28 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-runslide 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-runslide 30 AC Typical firmIndustry $/Q$/q qQ MC D S=  MC EQUILIBRIUM IN THE PIZZA MARKET IN THE SHORT-RUN. pEpE qEqE QEQE PIZZA MARKET Hidden slide

Competitive markets in the short-runslide 31 AC Typical firmIndustry $/Q$/q qQ MC D S p E =10 qEqE QEQE PIZZA MARKET THE EQUILIBRIUM PRICE RISES (BUT BY LESS THAN $2), AND QUANTITY FALLS FOR BOTH THE FIRM AND INDUSTRY. q(new) MC + 2 AC + 2 S + tax THE $2 TAX RAISES MC AND AC BY $2. p(new) Q(new)

Competitive markets in the short-runslide 32 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.