Short Run and Long Run Supply in Competitive Markets (Asad Mahmood)

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ASSIGNMENT

Short run and long run supply in

competitive markets

SUBMITTED BY:

Asad Mahmood

MBA 4th Morning

Roll No. 13

SUBMITTED TO:

Miss. Bushra Hamid

Institute of Management Studies

University Of Peshawar

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Contents

Short Run and Long Run Supply in Competitive Markets ................ 3

The Market Supply Curve ................................................................. 3

Market Supply with Many Identical Sellers ...................................... 4

The Effects of Changing a Variable Input Price ................................ 6

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Short Run and Long Run Supply in Competitive Markets

Market Supply Curves Markets with Homogeneous Suppliers The effects of changing input prices on short and long run supply The effects of changing technology on short and long run supply

The Market Supply Curve

Like the market demand curve, the market supply curve is just the sum of the quantities supplied by each seller at each market price.

Market supply, thus reflects the marginal costs of each of the producers in the market.

Agricultural Firm Cost Curves

The graph shows the cost curves for a single apple farm (identical to Jonathan's apple farm).

At a production level of 200 tons/year, marginal cost = average cost = $400.

The owners make no economic profits but all factors, including the owner's time are compensated at their opportunity cost.

Supply Curve for a New York Apple Farm

The data used to construct Jonathan's supply curve were representative of the typical New York State apple farm.

The supply curve for a single apple farm is shown above.

It is the same as the supply curve we have been using.

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Market Supply with Many Identical Sellers

In markets where there are many identical sellers of a homogenous product, it is important to distinguish between the "short run" and "long run" supply curves.

We have been talking about the "short run" supply curve because some factors were variable (labor) and some were fixed (space, managerial time).

Long and Short Run Supply

The long run supply curve measures the quantities of a good or service offered for sale by all sellers--potential and actual--who could sell in the market.

Long run supply is more elastic than short run supply.

New York State Apple Supply with Identical Firms

The table shows the short run supply of New York State apples with 1,700 firms identical to Jonathan's Apple Farm.

The table was constructed by multiplying the quantities from a single apple farm by 1,700 (total number of farms).

This is a short run supply curve because at prices below $400, some farms want to leave the market (average cost exceeds price) and at prices above $400 farms are making economic profits, so there will be entry of new farms.

Total number of farms

1,700

Quantity Supplied

(thousands of tons)

Marginal Cost =

Short Run Price

Average Cost

($/ton)

0

170 200 552

255 248 437

340 400 400

357 440 401

374 484 404

391 528 408

408 588 414

425 632 422

510 1,360 690

Short Run and Long Run Supply Curves

On the short run supply curve the number of firms in the industry is constant because no firm can change its fixed factors, which include land.

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On the long run supply curve all firms operate at the point where marginal cost equal average cost. The number of firms adjusts to vary the supply.

Remember, all firms are identical.

Long Run and Short Run NYS Apple Supply Curves

In the short run each of 1,700 apple farms moves along its marginal cost curve producing the short run supply shown in the table at the right.

In the long run each firm produces exactly 200 tons and the number of firms varies.

Thus, the long run supply curve is perfectly elastic at a price of $200/ton.

Total number of farms

1,700 Long Run

Quantity Supplied

(thousands of tons)

Marginal Cost =

Short Run Price

Average Cost

($/ton)

Long Run Price

($/ton)

Number of Apple

Farms

0

400 0

170 200 552 400 850

255 248 437 400 1,275

340 400 400 400 1,700

357 440 401 400 1,785

374 484 404 400 1,870

391 528 408 400 1,955

408 588 414 400 2,040

425 632 422 400 2,125

510 1,360 690 400 2,550

Graph of the NYS Apple Supply Curves

The graph shows the short run and long run supply curves for New York State apples. The short run curve is 1,700 (current number of farms) times the supply of a typical .

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The Effects of Changing a Variable Input Price

A variable input is one that can be adjusted in the short run. For the apple farm example above, hired labor is the only variable input. We are going to analyze the effects of increasing the price of a variable input on the

short and long run supply curves in a competitive product market.

Changing a Variable Input Price: Initial Firm Position

Initially, the firm operates along the MC curve.

Any quantity on this MC curve is a possible short run equilibrium.

The MC curve cuts the ATC curve at the minimum ATC.

The long run Q for the firm occurs at the minimum ATC.

This figure is the initial firm position for all of the examples that follow.

Changing a Variable Input Price: Initial Industry Position

The graph shows the entire market. The short run supply curve is the

sum of the MC curves for all currently operating firms.

The long run supply is infinitely elastic at the price equal to the minimum ATC for the initial input prices.

This figure is the initial industry position for all of the examples that follow.

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Changing a Variable Input Price: Firm-level Changes

The initial firm position is shown with the curves we used above.

When the price of a variable input increases, the new MC is above and to the left of the original.

The new ATC is above the original ATC curve.

The new minimum ATC is above the original.

The new long run Q occurs at the intersection of the new MC and new ATC.

Changing a Variable Input Price: Industry-level Changes

The graph, once again, shows the entire market.

The new short run supply curve, the sum of the MC curves for all currently operating firms, is above and to the left of the original supply curve.

The new long run supply is infinitely elastic at the price equal to the minimum ATC for the new input prices.

Increasing a Variable Input Price: Summary

When the price of a variable input increases: o Marginal cost increases for every firm. o Average total cost increases for every firm. o Minimum ATC increases for every firm. o Short run industry supply decreases, shifts to the left. o The long run industry supply curve shifts to a line infinitely elastic at the new,

higher minimum ATC.

What are the effects of decreasing a variable input price on the short and long run supply curves in a perfectly competitive industry?

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When the price of a variable input decreases: o Marginal cost decreases for every firm. o Average total cost decreases for every firm. o Minimum ATC decreases for every firm. o Short run industry supply increases, shifts to the right. o The long run industry supply curve shifts to a line infinitely elastic at the new,

lower, minimum ATC.

The Effects of Changing a Fixed Input Price

A fixed input is one that cannot be adjusted in the short run. In the apple farm example, land and the proprietor’s time are both fixed inputs. We are going to analyze the effects of increasing the price of a fixed input on short and

long run supply in a competitive product market.

Changing a Fixed Input Price: Firm-level Changes

The initial firm position is shown with the curves we used above.

When the price of a fixed input increases, the MC curve does not shift.

The new ATC is above the original ATC curve but its minimum is along the original MC curve.

The new minimum ATC is above the original.

The new long run Q occurs at the intersection of the original MC and new ATC.

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Changing a Fixed Input Price: Industry-level Changes

The graph, once again, shows the entire market, with the initial position shown in the curves we used above.

The short run supply curve, the sum of the MC curves for all currently operating firms, does not change.

The new long run supply is infinitely elastic at the price equal to the minimum ATC for the new input prices.

Increasing a Fixed Input Price: Summary

When the price of a fixed input increases: o Marginal cost does not change. o Average total cost rises. o Minimum average total cost rises. o Short run supply does not change. o The long run supply curve shifts to a line that is infinitely elastic at the new,

higher minimum ATC.

What are the effects of decreasing a fixed input price on the short and long run supply curves in a perfectly competitive industry?

When the price of a fixed input decreases: o Marginal cost is unchanged for every firm. o Average total cost decreases for every firm. o Minimum ATC decreases for every firm. o Short run industry supply does not change. o The long run industry supply curve shifts to a line infinitely elastic at the new,

lower, minimum ATC.

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The Effects of Improving a Firm’s Technology

A firm’s technology is the set of methods that it uses to convert inputs into product, called the

production function.

Improving a firm’s technology means that it is possible to produce more with the same fixed

and variable inputs.

Improving Technology: Firm-level Changes

The initial firm position is shown with the curves we used above.

When the technology improves, the new MC is below and to the right of the original

The new ATC is below the original ATC curve.

The new minimum ATC is below the original.

The new long run Q occurs at the intersection of the new MC and new ATC.

Improving Technology: Industry-level Changes

The graph, once again, shows the entire market, with the initial curves that we used for the industry in the examples above.

The new short run supply curve, the sum of the MC curves for all currently operating firms, is below and to the right of the original supply curve.

The new long run supply is infinitely elastic at the price equal to the new, lower minimum ATC corresponding

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to the improved technology.

Improving Technology: Summary

When technology improves in a competitive industry: o Marginal cost falls, shifts to the right. o Average total cost falls. o Minimum average total cost falls. o Short run supply increases, shifts to the right. o The long run supply curve shifts to a line that is infinitely elastic at the new,

lower minimum ATC.

Summary

The market supply curve is the sum of the quantities supplied by each firm at each price. Markets with homogeneous suppliers (agricultural products like New York State apples,

for example) have perfectly elastic long run supply curves. Changing the cost of a variable factor changes short and long run supply. Changing the cost of a fixed factor changes long run supply. Changing technology changes short and long run supply

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BIBLIOGRAPHY

http://www.questia.com

Review of The Long and the Short’, Economica, New Series, 26 (103),260-262.

Marshall, A. (1920). Principles of Economics, 9th ed., New York