Chapter 23
Firm Supply
Perfect competition
Perfect competition implies that the firm is a price-taker: its size relative to the market is infinitesimally small, so it cannot influence the output price p
As a price-taker, the firm will take p as given and just choose y to maximise profit
Demand curve facing firm
If the market price is p,then
at p > p, the firm cannot sell any y;
at p <= p*, the firm can sell up to the D(p)
The Supply Decision
The firm chooses y to maximise the profits, given by revenue minus costs π = py − c(y)
The first-order condition is
The firm will choose to supply at an output level where the market price is equal to its marginal cost
The Second Order Condition
Recall that MC(y) might have a U-shape: decreasing for low y, then eventually increasing
If this is the case, we also need to check that the second-order condition satisfies
That is,
=> marginal cost is non-decreasing
This indicates that the firm will only supply along the upward-sloping part of MC(y)
The Shutdown Condition
In the SR, fixed costs exist. This implies that in the SR, even an optimal choice of y might be making a loss for the firm
In the SR, the firm has to pay FC even if y=0.
The firm should produce at p=MC(y) if
This is called the shutdown condition and re-arranges to p>= AVC(y)
That is, the firm will produce as long as price covers its average variable costs
Notice that FC is incurred no matter what output decision the firm makes, so it doesn't influence output choice
The supply curve of the firm
The supply curve of the firm is the part of the MC curve that is above the AVC curve
Notice that when AC>MC>AVC, the firm is making losses but produces anyway
Producer Surplus
Revenue minus variable costs PS=py-VC(y)
Graphically, PS can be measured as the area under the price above the marginal cost at the chosen y
This is because revenue=p*y, and
so
Long Run Supply
The SR supply measures how much the firm would produce given that some input is fixed at k: p=MC(y,k)
The LR supply measures how much the firm would produce given that k can be adjusted optimally: p=MC(y,k(y))
In the LR, we would expect the firm's supply curve to be more elastic (more responsive to price) than in the short run
LR Shutdown Condition
In the LR, there is no FC, the firm will stay in the industry as long as the profits are non-negative:py-c(y)>=0 => p>=AVC(y)
Notice that since all costs are variable in the LR, thsi condition is the same as the SR shutdown condition