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Chapter Twenty-Three

Chapter Twenty-Three. Industry Supply. Supply From A Competitive Industry. How are the supply decisions of the many individual firms in a competitive industry to be combined to discover the market supply curve for the entire industry?. Supply From A Competitive Industry.

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Chapter Twenty-Three

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  1. Chapter Twenty-Three Industry Supply

  2. Supply From A Competitive Industry • How are the supply decisions of the many individual firms in a competitive industry to be combined to discover the market supply curve for the entire industry?

  3. Supply From A Competitive Industry • Since every firm in the industry is a price-taker, total quantity supplied at a given price is the sum of quantities supplied at that price by the individual firms.

  4. Short-Run Supply • In a short-run the number of firms in the industry is, temporarily, fixed. • Let n be the number of firms;i = 1, … ,n. • Si(p) is firm i’s supply function.

  5. Short-Run Supply • In a short-run the number of firms in the industry is, temporarily, fixed. • Let n be the number of firms;i = 1, … ,n. • Si(p) is firm i’s supply function. • The industry’s short-run supply function is

  6. Supply From A Competitive Industry Firm 1’s Supply Firm 2’s Supply p p S1(p) S2(p)

  7. Supply From A Competitive Industry Firm 1’s Supply Firm 2’s Supply p p p’ S1(p’) S1(p) S2(p) p p’ S1(p’) S(p) = S1(p) + S2(p) Industry’s Supply

  8. Supply From A Competitive Industry Firm 1’s Supply Firm 2’s Supply p p p” S1(p”) S1(p) S2(p”) S2(p) p p” S1(p”)+S2(p”) S(p) = S1(p) + S2(p) Industry’s Supply

  9. Supply From A Competitive Industry Firm 1’s Supply Firm 2’s Supply p p S1(p) S2(p) p S(p) = S1(p) + S2(p) Industry’s Supply

  10. Short-Run Industry Equilibrium • In a short-run, neither entry nor exit can occur. • Consequently, in a short-run equilibrium, some firms may earn positive economics profits, others may suffer economic losses, and still others may earn zero economic profit.

  11. Short-Run Industry Equilibrium Short-run industrysupply pse Market demand Yse Y Short-run equilibrium price clears themarket and is taken as given by each firm.

  12. Short-Run Industry Equilibrium Firm 1 Firm 2 Firm 3 ACs ACs MCs ACs MCs MCs pse y1 y2 y3 y1* y2* y3*

  13. Short-Run Industry Equilibrium Firm 1 Firm 2 Firm 3 ACs ACs MCs ACs MCs MCs pse P1 > 0 P2 < 0 P3 = 0 y1 y2 y3 y1* y2* y3*

  14. Short-Run Industry Equilibrium Firm 1 Firm 2 Firm 3 ACs ACs MCs ACs MCs MCs pse P1 > 0 P2 < 0 P3 = 0 y1 y2 y3 y1* y2* y3* Firm 1 wishesto remain inthe industry. Firm 2 wishesto exit fromthe industry. Firm 3 isindifferent.

  15. Long-Run Industry Supply • In the long-run every firm now in the industry is free to exit and firms now outside the industry are free to enter. • The industry’s long-run supply function must account for entry and exit as well as for the supply choices of firms that choose to be in the industry. • How is this done?

  16. Long-Run Industry Supply • Positive economic profit induces entry. • Economic profit is positive when the market price pse is higher than a firm’s minimum av. total cost; pse > min AC(y). • Entry increases industry supply, causing pse to fall. • When does entry cease?

  17. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) Mkt.Supply y Y Suppose the industry initially containsonly two firms.

  18. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) p2 p2 y Y Then the market-clearing price is p2.

  19. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) p2 p2 y2* y Y Then the market-clearing price is p2.Each firm produces y2* units of output.

  20. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) p2 p2 P > 0 y2* y Y Each firm makes a positive economicprofit, inducing entry by another firm.

  21. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) S3(p) p2 p2 y2* y Y Market supply shifts outwards.

  22. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) S3(p) p2 p2 y2* y Y Market supply shifts outwards.Market price falls.

  23. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) S3(p) p3 p3 y3* y Y Each firm produces less.

  24. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) S3(p) p3 p3 P > 0 y3* y Y Each firm produces less.Each firm’s economic profit is reduced.

  25. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S3(p) p3 p3 P > 0 y3* y Y Each firm’s economic profit is positive.Will another firm enter?

  26. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S3(p) S4(p) p3 p3 y3* y Y Market supply would shift outwards again.

  27. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S3(p) S4(p) p3 p3 y3* y Y Market supply would shift outwards again.Market price would fall again.

  28. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S3(p) S4(p) p4 p4 y4* y Y Each firm would produce less again.

  29. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S3(p) S4(p) p4 p4 P < 0 y4* y Y Each firm would produce less again. Eachfirm’s economic profit would be negative.

  30. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S3(p) S4(p) p4 p4 P < 0 y4* y Y Each firm would produce less again. Eachfirm’s economic profit would be negative.So the fourth firm would not enter.

  31. Long-Run Industry Supply • The long-run number of firms in the industry is the largest number for which the market price is at least as large as min AC(y). • Now we can construct the industry’s long-run supply curve.

  32. Long-Run Industry Supply • Suppose that market demand is large enough to sustain only two firms in the industry.

  33. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) S3(p) p2’ p2’ y2* y Y

  34. Long-Run Industry Supply • Suppose that market demand is large enough to sustain only two firms in the industry. • Then market demand increases, the market price rises, each firm produces more, and earns a higher economic profit.

  35. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) S3(p) p2’ p2’ y2* y Y

  36. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) S3(p) p2” p2” y2* y Y

  37. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) S3(p) p2” p2” y2* y Y

  38. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) S3(p) p2” p2” y2* y Y Notice that a 3rd firm will not enter since itwould earn negative economic profits.

  39. Long-Run Industry Supply • As market demand increases further, the market price rises further, the two incumbent firms each produce more and earn still higher economic profits -- until a 3rd firm becomes indifferent between entering and staying out.

  40. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) S3(p) p2” p2” y2* y Y

  41. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) S3(p) p2’” p2’” y2* y Y

  42. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) S3(p) p2’” p2’” y2* y Y A third firm can now enter, causing all firmsto earn zero economic profits.

  43. Long-Run Industry Supply • So any further increase in market demand will cause the number of firms in the industry to rise to three.

  44. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S2(p) S3(p) p2’” p2’” y2* y Y The only relevant part of the short-runsupply curve for n = 2 firms in the industry.

  45. Long-Run Industry Supply • How much further can market demand increase before a fourth firm enters the industry?

  46. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S3(p) S4(p) p3’ p3’ y3* y Y

  47. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S3(p) S4(p) p3’ p3’ y3* y Y A 4th firm would now earn negativeeconomic profits if it entered the industry.

  48. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S3(p) S4(p) p3’ p3’ y3* y Y But now a 4th firm would earn zeroeconomic profit if it entered the industry.

  49. Long-Run Industry Supply The Market A “Typical” Firm p p Mkt. Demand MC(y) AC(y) S3(p) S4(p) p3’ p3’ y3* y Y The only relevant part of the short-runsupply curve for n = 3 firms in the industry.

  50. Long-Run Industry Supply • Continuing in this manner builds the industry’s long-run supply curve, one section at-a-time from successive short-run industry supply curves.

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