welcome back to our discussion on perfectly competitive market where we have been discussing
about the supply curve of the firm so far we have discussed how the supply curve is
determined in the short run in the long run by the uh perfectly competitive firm and now
we are going to move on to look at how does the supply curve look like in a perfectly
competitive market this is what we are going to do but before that before we proceed to
determine what the market supply curve looks like we shall make some very simplistic assumptions
. so the assumptions that we make are all existing
firms and potential entrants have identical costs so what we are assuming is basically
the all the firms are exactly the same they look exactly the same they have exactly same
kinds of cost structures and any potential entrant who might enter the market later also
they also have very identical costs so uh this is not a very realistic assumption
because we know that even in a perfectly competitive setup also there are various firms of various
sizes and they have different kinds of cost structures so it is not a very realistic assumption
and we are going to see what happens if we relax this assumption later but for the time
being lets uh assume these and see what the market supply curve would look like
so the first assumption is all existing firms and potential entrants have identical costs
each firms costs do not change as new firms enter or exit the market so we are assuming
that if new firms enter the market or exit the market that does not change the cost situation
for the existing firms in the market so that also is not a very realistic assumption
because we may think that if there are huge number of entrants in a market there will
be a lot or pressure on the existing inputs that can happen right so in those situations
the cost of inputs may go up and costs may not remain the same as new firms enter or
exit the market as we are assuming here this assumption also we are going to relax later
and see how uh that changes our long run market supply curve
third we are assuming that the number of firms in the market is fixed in the short run because
of the fixed cost they can shut down but they dont exit the market and the number of firms
in the market is variable in the long run due to free entry and exit because it is easy
to enter or exit the market so in the long run the firms which are running at a loss
they are going to easily exit the market and firms uh or new entrants who are hoping for
some potential profit in this market they can enter the market so this is a realistic
assumption . now first the short run market supply curve
what does the short run market supply curve look like in the previous discussion we already
said that as long as price is above the average variable cost in the short run each firm will
produce its profit maximizing quantity at marginal cost equals marginal revenue equals
price so this is what we did in the previous module
and we showed that the short run supply curve of a firm is basically the minimum of the
average variable cost and from that point onwards it is the marginal cost curve of the
firm this is how we drew the short run uh supply function of a firm now market supply
is nothing but it is the aggregate of all quantities supplied by all firms at the market
price so at any market price all the firms whatever
output they are supplying the aggregate of all that is going to give us the market supply
curve but we know from our assumption from the previous slide we have already assumed
that all the firms are identical so let me draw the market supply curve what would it
look like . so if if this is a firm this is a typically
a typical firm and this is the price line and this is the marginal
cost and at p 1 say there are it produces 10 units of output it produces 10 units of
output at p 2 it produces 20 units of output at p 3 it produces 30 units of output and
so on so this is for the firm this is for a typical firm but by our assumption all firms
look like this all firms look like this and if we are assuming there are 1000 firms in
this market so what does the supply curve look like for the market
so for the supply curve also this market so for the supply curve if there are we are assuming
there are 1000 firms in the market and these firms are all similar by our definition by
our assumption so at p 1 10000 units of output is produced at p 2 20000 at p 3 30000 and
so on so this basically gives us the market supply
curve so this gives us the market supply curve here we have p here we have q and this is
the short run supply curve of the market this is the short run supply curve of the market
and which we arrive at from the individual firms supply curve .
okay now moving on in the long run what happens in the long run there is entry and exit in
the market so in the long run firms enter and exit the market and if existing firms
earn positive economic profit new firms enter the market so if there is positive economic
profit new firms are going to enter the market as the number of firms in the market goes
up supply curve shifts to the right and hence prices fall in the market slowing entry this
process continues till all existing firms earn zero economic profit in the long run
the firms which incur losses will exit the market in the long run thus shifting the supply
curve to the left and raising prices thus reducing losses of the remaining firms now
what happens here . so what happens is basically say let me show
what is being said in this uh in this slide say this is the
this is the market this is the market price quantity this is demand and this is supply
now there is this firm which is like any other firm and this is the price this is the price
and this is small q this is p and costs and this is the this is its price line which is
equal to mr ar and this is the marginal cost of this firm and say this is the average cost
of the firm so say this is the average cost of the firm
in the short run this is the market this is the firm so in the short run the firm is incurring
some profit why because this is the price line and at the intersection of marginal cost
and marginal revenue this is the q star is the optimum amount of output that the firm
is going to produce at q star the cost of the firm is c star and the profit that the
firm makes is this green region so in the short run the firm is making the
firm is basically making a profit of the amount of this green uh rectangle and looking at
the profit in the long run what will happen is more firms are going to enter the market
since there is positive economic profit to be made in this market and since we have assumed
that all the firms are similar in their in terms of cost they are they all are making
these profits so firms new firms enter the market
as new firms enter the market the supply curve in the market shifts to the right so as supply
shifts to the right so supply shifts to the right as new entrants new firms enter the
market supply shifts to the right and then the equilibrium price falls from p star to
p prime as it falls from p star to p prime we will see that gradually this process is
going to continue this process is going to continue till all this profit is wiped out
so so basically firms will keep entering the market and as firms keep entering the market
the supply curve will gradually shift to the right and as the supply curve keeps shifting
to the right price falls in the market till price reaches the minimum of the average total
cost of the firm so when the price reaches this minimum there is zero economic profit
to be made in the market and this is where the firms entry will stop
after this no more firms are going to enter in the market because already the existing
firms are making zero economic profit so in the long run the price is going to fall here
and in the long run price will come down to the minimum of the average total cost curve
and all firms will be operating at the level where price is equal to marginal cost is equal
to the minimum of the average total cost so that all firms incurring zero economic profit
so this is what has been said in the slide .
now lets discuss a little more about zero economic profit so in the long run entry and
exit is complete and all firms earn zero economic profit so for every firm in the long run price
is equal to average total cost also since profit maximizing condition for every firm
is marginal cost equals marginal revenue equals price in case of perfectly competitive market
marginal revenue is equal to price as we have discussed earlier
so the zero profit condition implies that marginal cost is now equal to price is equal
to average total cost because if the average total cost is less than price then there will
be positive economic profit But since zero profit condition has been reached so it is
basically marginal cost is equal to price is equal to average total cost
but at what point is marginal cost equal to average total cost at what point of the average
total cost curve is marginal cost equal to average total cost you may remember we had
discussed this when we had talked about the cost curves and we said that the marginal
cost intersects the average total cost at its minimum the marginal cost intersects the
average total cost at its minimum Hence in the long run price is equal to minimum average
cost so basically price is falling till where the
price is equal to the minimum average cost of average total cost of all the firms in
the industry because we have assumed all the firms have very similar cost all the firms
have exactly similar cost is what is our assumption so in the long run prices will fall as firms
keep entering the market prices will fall till the prices reach the minimum of the average
total cost of all the firms and just a quick recap why does the marginal
cost intersect the average total cost at its minimum because as we discussed earlier we
took the example of grade point average and this is another example i am going to give
say for example uh uh the the average cost of producing pizza is say uh say 100 rupees
and the the cost of producing an additional unit of pizza is going to be 105 rupees so
is the average if i produce that additional unit of pizza is my average cost going to
go up or down now since the average cost the marginal cost
is higher than the average cost so my average cost is going to go up if i produce that additional
unit of pizza on the other hand if the cost of producing an additional unit of pizza is
actually 98 rupees which is less than the average cost right now so if i produce that
additional unit of pizza my average cost is going to go down
so in that case my marginal cost when my marginal cost is below my average cost the the average
cost is falling when my marginal cost is above my average cost my average cost is rising
so my marginal cost will be equal to my average cost at the point where average cost is minimum
so this was the logic and coming back to our discussion so it basically means that if prices
fall uh keep on falling and price is equal to marginal cost is the profit maximizing
condition so basically price is for zero economic profit the price has to be equal to the average
total cost of the minimum average total cost of the firm okay so zero economic profit does
that mean that the firm is running at a loss or the so so where is the income coming from
so the firm is basically not getting anything because it is zero economic profit no if you
remember that we discussed about economy difference between economic profit and accounting profit
and we said that economic profit includes implicit cost or opportunity cost so when
you have zero economic profit that basically means that this profit includes implicit cost
hence zero economic profit means positive accounting profit that is the firm earns enough
revenue to cover its opportunity cost hence it stays in business
so economic zero economic so in the long run all perfectly competitive firms are going
to earn zero economic profit which means they have positive accounting profit and which
means it is they have they earn enough revenue to stay in business yet they operate at a
level where price is equal to their minimum total cost
in the next module we are going to extend this discussion a little more and look at
what happens when there are demand changes in the market and what happens to supply and
we are going to look at the long run uh supply curve of the firm in the next module thank
you