Microeconomics Monday-Short Run Supply Curves

Got off track from the holidays.  It’s time for a Microeconomic Monday and we will look at the firm’s short run supply curve today.

In the long run, firms can always exit the business.  It’s a possibility on any decision tree.  In the short run, firms may not have that choice.  In the short run, they try to stay in business and optimize their activity.  The supply curve they are faced with forces them to make choices in order to optimize.

What are the two possibilities in the short run”

1.   Operate producing where Quantity (Q)>0
2.  Temporarily shut down, and Q=0, but continue to pay Fixed Costs (FC)

Given our assumptions, Fixed Costs (FC) are sunk costs in the short run. Therefore, in short run decisions all fixed costs are ignored in analysis.

Graphically, the situation that confronts the firm looks like this:

The firm will produce based on the price it can get for it’s goods, and the costs of producing them.  As price changes, the quantity the firm produces changes too.  At higher prices, the firm will produce more, to a point. As we stated on earlier Microeconomics Mondays, cost curves are functions.  The marginal cost to produce one more has diminishing returns after a point on the curve.  As price drops, the firm will cut production.  If price drops low enough, the firm will temporarily shut down and continue to pay it’s fixed costs.

In the above graphic, at P1, the firm won’t produce.  At P2, it will produce enough to cover its Average Variable costs, but it won’t be earning a profit.  At P5, the firm earns a profit.

As price changes, it causes firms to change production. The firm always makes production decisions based on the Marginal Cost curve.  It always produces where MC(Q)=P.  Thus, the short run supply curve is the formula for the MC function.

Is there some point where the firm will shut down because it makes no sense to produce?  There is.  Graphically, the supply curve looks like this.

Thinking about this logically, the general rules are this:

• produce Q>0 if revenue can be larger than VC.  Otherwise set Q=0
• If PQ≥PC, then P≥AVC, and this is the cutoff P in the short run.
• If PAVC then set Q=0 (shut down temporarily, P=-FC)

The Short Run supply curve has two segments.  If P≥min AVC, the supply curve formula is the Marginal Cost curve.  By the way, we just derived that the firm’s supply curve has positive slope.  Recall all demand curves have negative slope.  If P

Here is a verbal problem.  Suppose Jack has a taxi company.  His fixed costs of operating are auto insurance, opportunity cost of the capital invested in the car, and his license.  Assume they equal $300.  The variable costs are labor, fuel, tolls and depreciation.  VC=10Q+.5Qsquared (or Q^2).  This means MC=10+Q.  To get to total costs, TC=300+10Q+.5Q^2; AC=300/Q+10+.5Q; AFC=300/Q; AVC=10+.5Q

Jack shuts down temporarily if P

MC intersects at min AVC.  Set MC=AVC and solve.

• MC=10+Q=10+.5Q—>minimized at Q=0.
• At Q=0, AVC=10
• Thus the cutoff price at which to temporarily shut down is P=10.

Short run supply curve equation for Jack is

• Q=O if P<10
• P=10+Q if P≥10 (or Q=-10+P; from formula for MC)

Hope you can follow this.  I was unable to load some cost tableau’s and will try to add them later.

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