The firm in the short run

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The firm in the short run

• 1. Alternative market structures
• 2. Assumptions of perfect competition
• 3. Short run equilibrium for the firm
• 4. Derivation of the supply curve

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ALTERNATIVE MARKET STRUCTURES

• Classification of markets
• number of firms
• freedom of entry to industry
• nature of product
• nature of demand curve
• The four market structures
• perfect competition
• monopoly
• monopolistic competition
• Oligopoly
• Structure conduct performance

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Features of the four market structures
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2. Assumptions Perfect Competition

• Assumptions (or characteristics)
• (i) firms are price takers
• price takers
• horizontal demand schedule (AR, MR)
• (ii) freedom of entry
• new firms can enter the market
• (iii) identical products
• Homogenous no brands thus no advertising
• (iv) perfect knowledge

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3. Short run equilibrium

• Two measures of profit
• (a) Normal profit
• level of profit keeping the firm in the same
  industry (long run)
• (b) Supernormal profit
• level (or rate) in excess of normal profit
• Short-run equilibrium of the firm
• Price, output profit

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3. Short run equilibrium

• A) Price
• price determined by demand supply
• Pe on figure
• B) Output
• profits maximised where MCMR
• output Qe
• market price is not affected by Qe
• firms output is a small of total output

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Short run equilibrium perfect competition
Price ()
S
AR, MR ()
D AR MR
Pe
D
O
O
Q (millions)
Q (hundreds)
(a) The market
(b) The firm
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3. Short run equilibrium

• C) Profit
• (i) If AC lt AR
• AC includes normal profit
• firm makes supernormal profit see figure
• a short run outcome

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Short-run equilibrium of industry and firm under
perfect competition
P
O
Qe
Q (millions)
(a) Industry
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3. Short run equilibrium

• C) Profit
• if AC gt AR
• MC MR is loss minimising
• Should the firm continue production?
• Yes, as long as price (AR) gt AVC
• See Figure

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Loss minimising under perfect competition
P

S
D
O
O
Q (thousands)
Q (millions)
(a) Industry
(b) Firm
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4. The short run supply curve of the firm

• Equal to the short run marginal cost curve
• supply curve relates P to Q
• MC curve relates Q (production) to Costs
• For profit max MR MC thus P MC (since P
  MR)
• Firms supply depends on costs of production
• MC is upward sloping supply upward sloping
• MC rise as output rises (diminishing returns)
• higher price induces greater output

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Deriving the short-run supply curve
P

S
D1 MR1
O
O
Q (thousands)
Q (millions)
(a) Industry
(b) Firm