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Long run supply when industry costs aren't constant

In some industries, the number of firms in the market has an impact on the costs that firms face. For example, when firms have to compete with each other over resources, firms' costs increase as more firms enter the market. But in other industries, more firms actually lower costs for firms. Learn about the implications of each of these situations on the long-run supply curve in an industry.

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  • blobby green style avatar for user sMichaelKr
    Am I right that Supply curve can't be downward slopping, but long run Supply curve can?
    (4 votes)
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    • starky ultimate style avatar for user Evan Li
      you have to consider the example he gives. In a decreasing cost market, input prices are lowered when more firms enter the market, which means that the new equilibrium price will also be lowered in the long run. This is what causes the downward sloping supply curve.
      (1 vote)
  • aqualine tree style avatar for user 9x9h
    At , how to explain in market graph that if the price a little bit higher, the cross-point of price and demand curve would be higher than the supply curve, which result in decrease of supply curve? In that way, supply would be upward sloping while the cost structure goes up, and this seems is different from in the vedio
    (2 votes)
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  • blobby green style avatar for user hanss.dengg
    why does the MC curve shift to the left?
    (1 vote)
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Video transcript

- [Instructor] What we have here we can view as the long run equilibrium or long run steady state for a perfectly competitive market. Let's say this is the market for apples and this is idealized perfectly competitive situation where you have many firms producing, they're non-differentiated, they have the same cost structure, there's no barriers to entry or exit. And on the left you can see that this equilibrium price which is set by the intersection of the supply and demand curves, that that's just going to be the price that the firms have to take and we've talked about that at length in other videos. That's going to define that the firm's marginal revenue, not just this firm, but all of the participants of the market. In other videos we've talked about the fact that the rational quantity for this firm to produce would be where marginal revenue intersects marginal cost. And it's also gonna be the point where you have zero economic profit, where at that quantity, let's say the quantity for the firm, your average total cost is equal to your marginal revenue. If marginal revenue were higher than average total cost at this quantity, well then you would have other entrants into the market because you're having positive economic profit. If marginal revenue is below average total cost at that quantity, well then firms are running economic losses and you will have people exiting the industry. And either of those situations would get us back to an equilibrium state that looks something like this. But now let's imagine a shock to the market somehow, let's say a new research study comes out that says that the apples that this market produces, that it's incredibly good for you, it'll make you live longer, it'll make you happier, it'll make you have more friends. Well then the demand for apples goes up, and so you have a new demand curve that looks something like this, D prime. Well in that situation, what's going to happen? Well now you have a new equilibrium price, you also have a new equilibrium quantity over here, let's call that P Prime. This is going to define a new marginal revenue curve, for the participants in the industry. So M, marginal revenue, prime. And now all of a sudden, the rational quantity for them to produce would be out here, at least for this firm to produce, so Q prime for, this firm is out here and you notice at that quantity, it is making economic profit. For every unit it gets that much, it costs that much on average for every unit, so it's making that much per unit, and then you multiply that times the number of units or the quantity. This whole area is going to be the economic profit that this firm is getting, and it's like that all of the firms, or most of the firms in this perfectly competitive market are going to be getting it 'cause they all have the same cost structure. But as we said before, when you have this positive economic profit, and there's no barriers to entry, in the long run, more firms will enter because there's economic profit to be had. And in previous videos, we've talked about a situation where as firms enter into a market, or exit a market, it doesn't change the cost structures of the individual firms. So let's imagine for a second that because of everyone entering into this market that seems to have economic profit for the firms that are participating into it, some of the inputs of say, growing apples, which is is what these firms do, start to go up in costs. So we're not talking about constant costs, perfectly competitive market, now we're not talking about an increasing cost, perfectly competitive market. Well then firm A and every firm's cost structure is going to change because as more firms come in, you're going to have to pay more for maybe apple seeds, pay more for maybe pesticides, or wax, or maybe you pay more for land on which to grow them. And so you would have a different marginal cost curve. We have the marginal cost curve now looks like this. So marginal cost curve prime. You would also have a new average total cost curve, maybe it looks something like this. So average total cost prime. And so, you can imagine that firms will jump into the market in order to capture or think that they might be able to get some economic profit, but they would only do so until the economic profit for all firms goes to zero. So what point will the economic profit go to zero? Well that's when the marginal revenue for the firms is equal to our marginal cost is equal to our average total cost. So it's that point right over there. So we would get to this point right over here, let's call that marginal revenue prime. And so, more and more firms would enter into the market up until the point that the equilibrium price gets us to P prime. And so the supply would increase, those folks wanna get that economic profit but it would increase until this point. So it'd shift a little bit to the right, and then we would get to S prime. As you can see, based on this we can now start to imagine a long run supply curve in this increasing cost, perfectly competitive market. We were over here, that was our equilibrium point before, now we are over here. And so our long run supply curve in this increasing cost environment, even though it's perfectly competitive, might look something like this. So in a constant cost world, this was a flat line. Now in an increasing cost world, as more and more people enter the market, the cost structure, the inputs into producing an apple go up, now long run supply is that. Remember, the long run is enough time to go by for people to enter and exit the market. Or enough time to go by so fixed costs aren't fixed anymore, that they can be shed or that they could be increased. Now you could do another thought exercise. Let's say we're dealing with a market where the more people that enter the market, the inputs actually get cheaper. And if that seems hard to believe, you can imagine, well, now people are able to produce seeds or wax at a new scale, so the inputs actually get cheaper. Well then you would see the opposite thing. Then you would see that as more entrants enter the market, this cost structure goes down, and so the supply can increase more and more and more and more, to a point that the equilibrium price is now lower than it was before, and then you would have a downward sloping long run supply curve.