A firm under perfect competition keeps operating in the short-run, so long as it is able to cover at least its variable costs.
Thus, a firm, which is not in a position to cover its short-run variable costs will choose to shut down its business by discontinuing its operations is the short-run. By doing so, the competitive firm minimises it losses in the short-run. Short run equilibrium of the firm is used to derive the short run supply curve of the competitive firm.
ADVERTISEMENTS:
The point at which the firm just covers its variable costs of production is called shut-down point or closing down point. With U-shaped cost curves, it is at the minimum point of the average variable cost. The corresponding price is called the shut down price or reservation price, below which the firm will not sell its product.
Further, the corresponding output is called is shut down output. The concept of shut-down point can be used to derive the supply curve of a competitive firm in the short-run, as explained here.
Image Source: images.slideplayer.com
In the short-run, if the market price is too low to cover even its variable costs (i.e., total revenue (TR) < total variable cost (TVC)), the firm should close down its business and should not supply any output. But, if the price (P) is equal to or more than average variable cost (AVC), the firm should produce and supply an output corresponding to which marginal cost (MC) cuts marginal revenue (Mr = P) from below (equilibrium condition).
If the market price is OP0, the firm will supply an output of OQ0 and operate at equilibrium point E0, where MC is equal to MR. Similarly, when the price rises to OP1, the firm will supply an equilibrium output of OQ1. Further, when the price rises to OP1, the firm raises the supply to OQ2 Likewise, the firm supplies OQ3 output at OP3 price.
ADVERTISEMENTS:
In Fig. 13.7, OPQ is the minimum acceptable price in this short-run for the firm under consideration, below which the firm stops production. At this price, only variable costs are covered. The corresponding equilibrium point EQ is the shut-down point of the firm, where price (P) = minimum of average variable cost (AVC) and TR = TVC.
As the market price increases gradually, the firm confronts new demand curves at higher and higher levels. With positive slope of the MC curve, each higher demand curve (AR=MR) cuts the given MC curve at a point, which lies to the right of previous intersection.
This means that the quantity supplied by the firm along its MC curve increases, as price rises in the short-run. The horizontal coordinate of a point on the rising MC curve measures the quantity of product that the firm will supply at that price. Thus, the MC curve of the firm indicates the quantities of output which the firm will supply at various prices.
It is important to note that the competitive firm’s short-run supply curve is identical with only that portion of the short-run MC curve, which lies above the AVC curve. It is derived by joining the points of intersection of the MC curve with the successive individual demand curves, as the market price of the product keeps rising above its average variable cost. The quantity supplied by the firm is equal to zero at all prices less than those corresponding to the shut-down point. The firm’s supply curve is shown by dark segment in Fig. 13.7.
Long-Run Supply Curve of a Competitive Firm:
ADVERTISEMENTS:
The derivation of long-run supply curve of a competitive firm is similar to the derivation of its short-run supply curve, as shown in Fig 13.8 by dark segments. The firm’s long-run optimal output corresponding to different price levels is determined by the equality of price (AR = MR) and the long run marginal cost (LMC). Zero output is produced at prices less than the long-run average cost (LAC)
In Fig. 13.8, OP is the minimum acceptable price in the long run, since no firm can suffer losses in the long run. At this price, the competitive firm attains equilibrium at point EQ and supplies OQ0 output. At price OP1, equilibrium is attained at point E, with OQ, as the output produced.
Further, at OP2 price, the output supplied is OQ2, while the output supplied is OQ3 at OP3 price and so on. All equilibrium points, such as EQ, E1, E2 and E3 lie on the firm’s LMC curve. These points also show the supply of the competitive firm in the long-run at various prices.
Therefore, the portion of LMC curve of the competitive firm above its LAC curve is its long run supply curve. Long-run supply curve of a perfectly competitive firm is, thus, derived by joining together the points of intersection of the LMC curve with the successive demand curves of the firm, as the market price of the product under consideration keeps rising above its average cost.
