Question

Deriving the short-run supply curve

Consider the competitive market for halogen lamps. The following graph shows the marginal cost (MC), average total cost (ATC), and average variable cost (AVC) curves for a typical firm in the industry.

100 T 90 80 70 2 60 O 50 TC O 40 30 20 10 AVC 0 5 10 15 20 25 30 35 40 45 50 QUANTITY (Thousands of lamps)

For each price in the following table, use the graph to determine the number of lamps this firm would produce in order to maximize its profit. Assume that when the price is exactly equal to the average variable cost, the firm is indifferent between producing zero lamps and the profit-maximizing quantity. Also, indicate whether the firm will produce, shut down, or be indifferent between the two in the short run. Lastly, determine whether it will make a profit, suffer a loss, or break even at each price.

On the following graph, use the orange points (square symbol) to plot points along the portion of the firm's short-run supply curve that corresponds to prices where there is positive output. (Note: You are given more points to plot than you need.)

Suppose there are 8 firms in this industry, each of which has the cost curves previously shown.

On the following graph, use the orange points (square symbol) to plot points along the portion of the industry’s short-run supply curve that corresponds to prices where there is positive output. (Note: You are given more points to plot than you need.) Then, place the black point (plus symbol) on the graph to indicate the short-run equilibrium price and quantity in this market.

Note: Dashed drop lines will automatically extend to both axe

At the current short-run market price, firms will: a) shut down b) produce in the short run. In the long run: a) firms will neither enter nor exit b) some firms will enter c) some firms will exit

Answer 1

The given table may be filled up as follows Price (dollars per jacket) (jackets) 10 Quantity Produce or Profit or loss? shut down? Shut down Loss 0 units (Explanation: This price equals marginal cost at the quantity level of 20,000. At this quantity level the AVC is higher than the given price level of S10. Therefore, the firm will not produce anything.) Either 0 or 30,000 units (Explanation: This price equals marginal cost at the quantity level of 30,000. At this quantity level, the AVC equals the price level of $20, making the producer indifferent between producing and shutting down.) 35,000 units (Explanation: This price equals marginal cost at the quantity level of 35,000 units. At this quantity level, the price of S32 is higher than AVC. Therefore, the firm will keep producin 37.500 units (Explanation: This price equals marginal cost at the quantity level of 37,500 units. At this quantity level, the price of $40 is higher than AVC. Therefore, the firm will keep producing. 40.000 units (Explanation: This price equals marginal cost at the quantity level of 40,000 units. At this quantity level, the price of S50 is higher than AVC. Therefore, the firm will keep producing. 42,500 units (Explanation: This price equals marginal cost at the quantity level of 42,500 units. At this quantity level, the price of $60 is higher than AVC. Therefore, the firm will keep producing (Explanation: At zero output, there is no variable cost; however, the firm still incurs fixed cost.) 20 Indifference Loss (Explanation: If the firm produces, only variable costs will be recovered. If the producer shuts down, the firm shuts down, fixed cost are still incurred Loss (Explanation: At the quantity level of 35,000 units, the average total cost is higher than the 32 Produce rice level of $32 Loss (Explanation: At the quantity level of 37,500 units, the average total cost is higher than the price level of $40.) 40 Produce 50 Produce No profit no loss (Explanation: At the quantity level of 40,000 units, the average total cost equals the price level of $40.) Profit (Explanation: At the quantity level of 42,500 units, the price level of $60 is higher than the average total cost.) 60 Produce

Firm's short run supply curve is that portion of the marginal cost curve that lies above the minimum level of AVC. Therefore, the short run supply curve of a single firm is as follows: 70 60 50 40 30 20 10 Price per unit 10 20 30 40 Thousands 50 Quantity There are eight firms. This means the industry's supply curve will be the horizontal summation of eight individual supply curves. E.g. at the price level of S50, the individual firm's quantity supplied is 40,000 units; this means the industry's supply curve is 320,000 units 40,000 units x 8)

The industry's supply curve may be plotted with the given demand curve as follows: 80 70 Supply 60 50 40 Demand 30 20 10 0 0 0 50 100150 200 25000 350 400 Quantity (in thousands) The intersection of demand and short run supply curve show that the short run market price is $40 per unit. Our table shows that at this price level, firms will produce in the short-run. The table also shows that the firms will make a loss at this price, which means that in the long run, some firms will exit.