Slide 1Knowledge RecapMarket Supply with CompetitionMarket Supply with CompetitionMarket Supply with CompetitionMarket Supply with CompetitionDemand Shifts in CompetitionDemand Shifts in CompetitionMarket Supply in CompetitionECON 203: Principles of MicroeconomicsClass 15: Market Supply in Competitive Markets1Knowledge Recap•Total profit is maximized when MC = MR.–In competitive markets MC = MR = P•Profit = TR – TC = P*Q – ATC*Q = (P – ATC)*Q•In the short-run: –Fixed costs are sunk (cannot be recovered).–A firm will shut-down if P < AVC.–If AVC < P < ATC, a firm will operate with short-run losses.•In the long-run:–All costs are variable (fixed costs can be recovered).–A firm will exit the market if P < ATC.–With long-run losses, firms exit the market.2Market Supply with Competition•Individual firms’ supply in the short- and long-run.–In the short-run, firms will operate as long as P >= AVC short-run supply is MC if P >= AVC and 0 below AVC.–In the long-run, firms will only stay in the market if P > ATC long-run supply is MC if P >=ATC and 0 below ATC.•Market supply in the short- and long-run.–In the short-run, the number of firms in the market is fixed.–In the long-run, the number of firms in the market can adjust in response to changing market conditions.•Firms exit market if P < ATC.•Firms enter market if P > ATC.3Market Supply with Competition•Market supply in the short-run.–Consider 1,000 identical firms (number fixed).–Supply of each firm:•If P > AVC supply equals MC curve.•If P < AVC supply is zero.–Market supply equals the sum of the quantities supplied by each firm (1,000 * Q supplied each firm). –As long as P > AVC, market supply equals horizontal sum of individual MC (supply) curves. 4Market Supply with Competition•Market supply in the long-run.–Firms can exit and enter the market (number can change). –Assumption: homogenous technologyidentical cost curves.–Decisions of individual firms:•Enter market if P > ATC (firms in the market make profits).•Exit market if P < ATC (firms in the market have losses).–Market response:•When P > ATC:Firms enter market Increase in total Q Decrease in P along the Demand curve•When P < ATC:Firms exit market Decrease in total Q Increase in P along the Demand curve5Market Supply with Competition•Market supply in the long-run.–In equilibrium:•P = ATC, and under perfect competition P = MR = MC = ATC.•Firms make zero (economic) profits.–In the long-run there is only one price equal to minimum ATC.•Long-run supply is perfectly elastic (horizontal).6Demand Shifts in Competition•Example 1: news on benefits of organic tomatoes.–Shift demand for organic tomatoes to the right.–Increase in price leads to short-run profits.–Firms enter and short-run supply shifts right.–In the long-run:•P go back to original where P = ATC•Q increases.7Demand Shifts in Competition•Example 2: news on dangers of gluten (bread).–Shift demand for bread to the left.–Decrease in price leads to short-run losses.–Firms exit and short-run supply shifts left.–In the long-run:•P go back to original where P = ATC•Q decreases.8Market Supply in Competition•Conclusions.–In the short-run, market supply equals to the horizontal sum of individual firms’ MC curves.–In the long-run, market supply is perfectly elastic (horizontal) at a price where P = ATC = MC (efficient scale).•Caveats.–Conclusions hold only if resources are unlimited and firms have identical cost structures.–With limited resources and different cost structures long-term supply may be upward
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