Short Run
Supply Curve of a Price Taker Firm:
Definition and Explanation:
In a competitive market, the
supply curve of a firm is derived from its
marginal cost curve. Supply curve
is that portion of the marginal cost curve which lies above the
average variable cost curve.
As we already know, the aim of
the firm is to maximize profits or minimize losses. The profits
are increased it the difference between total receipts and total
costs is maximized. When a firm undertakes the production of a
particular commodity, it has to pay remuneration to all the
factors of production employed. The remuneration or cost of the
firm for a short period can be divided into two parts, fixed
costs and variable costs. If from the sale of the commodity
produced, a firm is earning much more than what it has to spend
on it. We say a firm is earning abnormal profits if the total
revenue of the firm is equal to total cost, the firm is getting
normal profits. In both these cases, it is profitable for the
firm to produce the commodity. But if the total receipts fall
short of total costs, then three situations can arise.
(i) A firm is not in position to
meet its variable costs.
(ii) A firm is able to cover its
variable costs.
(iii) A firm is covering its full
variable costs and a part of the fixed costs.
Let us explain all these
situations with the help of a curve.
Diagram:
(1) In the
figure. (15.7) there are three costs curves, AVC curve, ATC
curve and MC curve. ATC curve includes the average variable cost
and average fixed cost of a firm. Average variable cost is
represented by the AVC curve which lies below the ATC curve. Let us
suppose now that at price OM, a firm supplies an
output equal to 01 because MR = MC at point I.
The total
receipts of the firm at OM price are thus, equal to OILM, while
the total costs are equal to OIKN. At this price, a firm is
undergoing too much losses which are represented by the area
MLKN. It is not even meeting its full variable cost as the AVC
curve lies much above this price line. A firm shall have to
close down its operations for minimizing losses in the short run
(shut
down cases).
(2) At price
OF, a firm is in equilibrium at point E where MR = P = AR. It
produces OD amount of output and is just able to cover its
variable cost. The total receipts of the firm at OF price are
equal to ODEF and the total cost ODGH. As the total receipts
of-the firm fall short of total cost, so it Is not advantageous
for the firm to carry on production in the short run. The firm
shall close down its operation as the full fixed cost equal to
the area FHGE is not met. The point E where MR = MC = minimum of
AVC is also a shut down point of the firm.
(3)
In case
the price settles somewhere between F and G, then the firm will
be meeting its full variable costs and a part of the fixed
costs. It, may prefer to produce because if the concern is
closed down the whole of the fixed cost is to be met. This, of
course can happen in a short period. When the period is long the
total receipts of the firm must be equal to total cost and the
firm must earn normal profit.
(4)
If the
price in the market is OG, the firm is in equilibrium at point
B. Here the total receipts of the firm, i.e., OABG are equal to
the total cost, i.e., OABG. A firm is earning normal profits and
it is profitable for it to carry on production. By normal
profits in economics we mean the level of profit which is just
sufficient to induce an entrepreneur to stay in the industry.
The amount is equal to the remuneration which an entrepreneur
can get in an alternative occupations. If the entrepreneur is
not paid the amount equal to this normal profit, he will move to
the other alternative industry where he could got this amount.
If price,
rises above OG, then firm is getting abnormal profits. For
instance, the firm is producing best level of output by equating
MR = MC at point U and selling at price OZ, the total revenue of
the firm will be OWUZ and total cost OWVP. There is thus an
abnormal profit equal to PVU2.
Summing up,
we can say, that if price falls below the lowest point on the
AVC curve, the firm will not produce any output because it is
not able to cover even its total variable costs. But if the
price is such that it covers its total variable costs, then the
firm may carry on production for a short period. So is also the
case when it covers its full variable costs and a part of the
fixed costs. In the long period, if the firm does not cover its
full costs, it will have to dose down its operations sooner or
later. So we conclude that the supply curve of the firm that can
be regarded as that portion of the MC curve which lies above the
AVC curve and not which lies below the AVC curve because it is
only at the lowest point on the AVC curve that some output is
forthcoming and not below this point.
The supply
curve of the firm or the rising portion of the MC curve which
lies above the AVC curve can be split up into two parts. One
part consists of that portion which lies above the lowest point
of the ATC curve. If the price line representing MR = AR
intersects the MC curve at any point on this rising portion, the
firm will be earning abnormal profit (see fig. 15.7). The second
part of the supply curve of the firm extends from the lowest
point of the AVC curve to the lowest, point of the ATC curve. If
price line representing MR = AR passes through the lowest point
of the AVC curve, the firm is covering only total variable
costs. If the price line cuts the MC curve at any point above
the lowest point of
the AVC curve and below the lowest point of ATC curve, the firm
will be meeting its total variable costs and a part of the fixed
costs but not the total costs. The total costs are met only when
the price line forms a tangent to the ATC curve.
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