Market Supply Curve in the Short Run and Long Run - Online Tutor, Practice Problems & Exam Prep

In the short run, the market supply curve is derived from the sum of individual firms' marginal cost curves, reflecting their willingness to supply at various prices. In the long run, firms earn zero economic profit, as price equals average total cost (P = ATC), leading to a perfectly elastic supply curve. This equilibrium ensures that firms enter or exit the market based on profitability, maintaining a balance where demand is met without excess supply or demand. Understanding these dynamics is crucial for grasping market structures and competition in economics.

Market Supply Curve in the Short Run

Alright, so we saw how the individual firm's supply curve acts in the short run and the long run, now let's try the market supply curve. So first let's start with the short run here, right? A key feature of the short run is that the number of firms in the market is fixed, okay? So in the short run, right? So what we're going to see is that the market's short run supply curve, this is similar to what we've seen when we studied supply and demand and built the individual supply into the market supply, well it's just going to be the sum of the individual firm's marginal cost curves, right? And as we saw with the individual firms, we saw that the marginal cost curve is their supply curve when they do supply, right? So whenever they are above that average variable cost in the short run, that's when we supply and that supply is going to be the marginal cost. Alright, so here on the graph I've got an example of what an individual firm marginal cost might look like and this is pretty standard stuff. We see just kind of an upward sloping line like we'd expect from marginal cost and an individual firm in this hypothetical situation at a price of $5 would supply 100 and at a price of $10 would supply 200, right? This is just kind of arbitrary but the idea is if we were going to get to the market supply, right? So this is the individual firm supplying these amounts at different prices right? So if we were to take this to the whole market right? Let's imagine that there's a 1,000 firms that are exactly the same. In real life it probably wouldn't be that way but just to make this point, let's say that there's a 1,000 firms that have the same marginal cost curve that we see for this individual firm. Right? Well, what we would do is we would just add all of those marginal costs together at each price, right, and we would say at a price of $5 a 1,000 firms that are identical to this one would produce 100,000, right? 100 times the 1,000, so we would just see that the market supply would be 100,000 right? We're adding all of those together, the 1,000 different firms that there are all with the same marginal cost. So this is pretty simple stuff, I don't want you to get too hung up on it because it's stuff we've seen before. If you want a lot more detail in how we construct this market supply, I'd go back to a video from our supply and demand chapter and I believe it was just called supply versus market supply. Okay, so you just type that in the search bar and I'm sure it'll come up and you can get a little more detail there, but really what's happening is we're just adding all of the firm's marginal cost together to get to the supply curve of the market. Alright, so it's pretty simple. There's a lot more going on in the long run, so let's go ahead and check that out in the next video.

Market Supply Curve in the Long Run

Alright. So we saw the short run for the market supply. Now let's check out the long run for the market supply. One thing I want to note is that, in the long run, firms are going to earn 0 economic profit. They are not going to earn any economic profit, right? And you might be thinking, so why are they going to be in business? Remember that economic profit includes non-monetary opportunity costs, right? So there are some opportunity costs for the firm, say things that the owner could be doing instead, right? Instead of running this farm where they're producing wheat, maybe they could be doing something else. That's a non-monetary opportunity cost, right? So those are getting taken into account when we get to this zero economic profit condition. There's still positive accounting profit, right? When we think of just dollars leaving and dollars coming in, there is going to be some accounting profit, and that helps the owner of the firm take account for these opportunity costs, right? That's the reason they're going to be in business. So right here we've got a profit or loss equation like we're used to, we've got our P - ATC × Q, right? We've seen that so far, the P - ATC being the profit per unit and then we multiply it by quantity. Okay? So let's see how we end up at this 0 economic profit in the long run.

So let's start in a situation where we're in the short run and we are making profit right? There's some short-run situation where the price is greater than average total cost right and we are making money. So what happens when other people see you making money? They're like, hey, they're selling wheat and they're making money. Other firms are going to enter; firms will enter the market, right? Other people will start farming wheat because they see that there are profits to be made. So we saw this in the supply and demand chapter right where we saw that when firms enter the market, the number of suppliers increases, well supply is going to shift to the right, and when supply shifts to the right, well that price is going to fall, right?

So we could do a quick test; let’s might as well do it right here. I'll do it on the side just so you can see what I mean here. So we've got our standard downward demand, upward supply. Let me draw those a little better. Right? So that would be our original situation and there were profits being made. So firms enter the market and we're going to have a new supply curve, right? This was supply and demand here. Well, we're going to have our new supply when firms enter over here, right? This will be S2 that was S1, right? So S2 is after the firms have entered and what do we see happening? Here was the original price and now look at the price, the price is lower right? So the price falls when firms enter the market and you can imagine the opposite, the price is going to rise when firms leave the market, okay? So let's say right here we had firms entering the market and the price falls, right? And then let's say it was enough that the price now is below average total cost, right? So now in the short run, people are making losses. Well now that there are losses, firms are going to exit, right? If they can't cover their average total cost, firms are going to exit in the long run. Right? So firms will exit in these loss situations and what's going to happen? Well just like we discussed the price is going to go up, right? So this is going to keep happening until it finds its equilibrium and that equilibrium is where P = ATC right? Because if it's above ATC firms will enter, if it's below ATC, firms will exit until it finds this P = ATC condition right and when price equals ATC, if this is say $5 price and this is $5 ATC, well we've got 0 there, right? There's 0 economic profit when the price equals ATC. Cool?

So let's look down on these graphs and see how this leads us to our long-run market supply. Alright, so we see an individual firm making zero profit right? We've got this price which is equal to the minimum ATC, right? This price right here, where can I write it? I'll put p = minimum ATC, right? And that's what we see on the graph. This price is crossing the ATC at its minimum, right? So what's happening here is that at that minimum price, the market is going, firms will be entering and exiting the market right? Until we find the right amount of firms that can supply the demand or fulfill the demand at that price, right? So what we end up seeing with the long-run market supply is that it ends up being a flat line just like this, this perfectly elastic supply curve in the long run. So at any demand, right, it's going to be fulfilled by these individual firms, right? So we're going to have just enough firms in the market to fulfill the supply or excuse me fulfill the demand regardless of where it is. The demand could be right down here and it will be fulfilled, the demand could be here and it's going to be fulfilled right, no matter where it is there's going to be enough firms producing at their minimum ATC to fulfill that demand, right? Because if there wasn't enough firms, the price would go up, there would be short-term profit, firms would enter bringing the price down, right? So we would see this continuing to happen until we reach this stable equilibrium with this price at minimum ATC. Cool, so that market supply in the long run is going to have that flat, perfectly elastic shape. Alright, so let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What is the difference between the short run and long run market supply curve?

In the short run, the market supply curve is derived from the sum of individual firms' marginal cost curves. This reflects the firms' willingness to supply at various prices, assuming the number of firms in the market is fixed. In contrast, the long run market supply curve is perfectly elastic, meaning it is a flat horizontal line. This occurs because firms can enter or exit the market freely, leading to zero economic profit (P = ATC). In the long run, the market adjusts to ensure that supply meets demand at the minimum average total cost, maintaining equilibrium without excess supply or demand.

How is the market supply curve constructed in the short run?

The market supply curve in the short run is constructed by summing the individual marginal cost curves of all firms in the market. Each firm's marginal cost curve represents its supply curve when the price is above the average variable cost. By adding these marginal costs at each price level, we obtain the total quantity supplied by the market. For example, if 1,000 identical firms each supply 100 units at a price of $5, the market supply at that price would be 100,000 units.

Why do firms earn zero economic profit in the long run?

In the long run, firms earn zero economic profit because the market reaches an equilibrium where the price equals the average total cost (P = ATC). This happens because if firms are making a profit, new firms will enter the market, increasing supply and driving down the price. Conversely, if firms are making losses, some will exit the market, reducing supply and driving up the price. This process continues until firms earn just enough to cover their opportunity costs, resulting in zero economic profit but still positive accounting profit.

What happens to the market supply curve when firms enter or exit the market?

When firms enter the market, the market supply curve shifts to the right, increasing the total quantity supplied and typically lowering the market price. Conversely, when firms exit the market, the supply curve shifts to the left, decreasing the total quantity supplied and typically raising the market price. These shifts continue until the market reaches a new equilibrium where firms earn zero economic profit, ensuring that supply meets demand at the minimum average total cost.

How does the concept of zero economic profit affect market equilibrium in the long run?

The concept of zero economic profit ensures that in the long run, the market reaches an equilibrium where the price equals the average total cost (P = ATC). This equilibrium is achieved through the entry and exit of firms in response to profits and losses. When firms earn profits, new firms enter, increasing supply and lowering prices. When firms incur losses, some exit, decreasing supply and raising prices. This dynamic continues until firms earn just enough to cover their opportunity costs, resulting in zero economic profit and a perfectly elastic long run supply curve.