Whoever claims that economic competition
represents 'survival of the fittest' in the sense of the
law of the jungle, provides the clearest possible
evidence of his lack of knowledge of economics.
-George Reisman
The marginal cost curve is the shortrun supply curve for a competitive
firm.
Supply curve – A curve describing
the quantities of a good a
producer is willing and able to sell
(produce) at alternative prices in a
given time period, ceteris paribus.
Price (per bushel)
$18
16
14
12
10
8
6
4
2
0
X
Shutdown
point
Y
Marginal
cost curve
1
2
3
=
Short-run supply curve
for competitive firm
4
5
Quantity Supplied (bushels per day)
6
7
Marginal revenue & marginal
cost
(dollars per day)
MC
31
25
AVC
17
Amount by which
variable cost exceeds
revenue
15
Revenue
5
7
9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
MC = S
31
25
AVC
MR0
17
Revenue =
variable cost
7
9 10
Quantity (sweaters per day)
Marginal revenue & marginal cost
(dollars per day)
S
31
25
17
s
7
9 10
Quantity (sweaters per day)
Short-run industry supply curve
Shows the quantity supplied by the
industry at each price
plant size of each firm constant
the number of firms constant
It is constructed by the horizontal
summation of all firm’s supply curves.
($)
MC1
S
MC2
p0
0
q1
q2
Q
Q0
The quantity of a good supplied is
affected by all forces that alter
marginal cost.
The determinants of a firm’s
supply include:
The price of factor inputs
Technology
(the available
production function)
Expectations (for costs, sales,
technology)
Taxes and subsidies
If any determinant of supply changes,
the supply curve shifts.
The investment decision is the
decision to build, buy or lease
plant and equipment.
It also involves the decision to
enter or exit an industry.
The shut-down decision is a short-run
response. In the short-run, the firm must
decide:
Whether to produce or to shut down.
If produce, what quantity? Start with
quantity decision
Investment
decisions
are
long-run
decisions.
Long-run – A period of time long
enough for all inputs to be varied (no
fixed costs).
When price does not cover average
variable costs at any rate of output,
production should cease.
The shutdown point is that rate of
output where price equals minimum
AVC.
shutdown
point
price
minimum
=
AVC
Profit
18
16
Price or Cost
14
12
10
Loss
MC
ATC
Price
(=MR)
X
Shutdown
MC
ATC
ATC
AVC
MC
AVC
Price
Y
8
AVC
6
Price
4
shutdown point
2
0 1 2 3 4 5 6 7 8 0 1 2 3 4 5 6 7 8 01 2 3 4 5 6 7 8
Quantity
Quantity
Quantity
The short-run profit maximization rule
does not guarantee any profits.
Fixed costs must be paid even if all
output ceases.
A firm should shut down only if the
losses from continuing production
exceed fixed costs.
In the long-run, all inputs are variable.
There is no fixed cost.
In making long-run decisions, the
producer is confronted with many
possible cost figures.
A producer will want to build, buy or
lease a plant that is most efficient
for the anticipated rate of output.
Long-run cost
The firm uses the economically
efficient quantities of labor and
capital (least cost for the output).
This generates a firm’s long-run
average cost curve.
The long run average total cost curve
is derived from the short-run average
total cost curves.
Some tax changes alter short-run
supply behavior.
Others affect only long-run supply
decisions.
Property taxes are a fixed cost.
They raise average
reduce profit.
costs
and
Because
they
don’t
affect
marginal costs, they leave the
profit-maximizing
output
unchanged.
Payroll taxes increase marginal
costs.
They
reduce
the
maximizing rate of output.
profit
They increase average costs and
lower total and per-unit profits.
Profit taxes are neither a fixed cost
nor a variable cost.
They don’t affect marginal cost or
prices.
They don’t affect production level
decisions but may affect investment
decisions.
Payroll taxes
alter marginal
costs.
Property taxes
affect fixed
costs.
MCb
MC1
MC1
ATCa
ATC1
pe
ATCb
ATC1
pe
q1
Profit taxes
don't change
costs.
qb q1
MC1
ATC1
pe
q1
Returns to scale refer to the
increases in output that result from
increasing all inputs by the same
percentage.
Also referred to as economies of
scale.
A given % increase in all the firm’s inputs
results in a larger % increase in output.
ATC0 = TC/q
ATC1 = 2TC/3q < ATC0
20
TC0 = 64 ATC0= 8
ATC0
TC1 = 2TC0 = 128 ATC1= 5.3
9
ATC1
8
5.3
0
5
8 10
13 15
20
Output (sweaters per day)
24 25
A given % increase in all the firm’s
inputs results in the same % increase
in output.
ATC0 = TC/q
ATC1 = 2TC/2q = ATC0
20
TC1 = 2TC0 = 128 ATC1= 8
TC0 = 64 ATC0= 8
ATC0
ATC1
9
8
5.3
0
5
8 10
13
15 16
20
Output (sweaters per day)
24 25
A given % increase in all the firm’s
inputs results in a smaller % increase
in output
ATC0 = TC/q
ATC1 = 2TC/1.5q > ATC0
20
TC0 = 64 ATC0= 8
ATC1
ATC0
TC1 = 2TC0 = 128 ATC1= 10.7
10.7
8
5.3
0
5
8
10
13
15
Output (sweaters per day)
20
24 25
Economies of Scale
Diseconomies of Scale
Constant
Returns
0
Output (sweaters per day)