Assume you are in the early stages of your coffee manufacturing business and have already invested a significant amount of money. What should your short-term goal be to manage your business successfully? Should your goal in the short run be to make millions of dollars in profit or just enough to cover your expenses? To find out, let's dive straight into the short-run supply curve article!
Short Run Supply Curve Definition
What is the definition of the short run supply curve? To understand it, let's remind ourselves of the model of perfect competition.
The perfect competition model is excellent for analyzing a range of marketplaces. Perfect competition is a model of the market assuming that numerous firms are each other’s direct competitors, produce identical goods, and operate in a market with low entry and exit barriers.
In a perfectly competitive market, the firms are price takers, meaning that the firms do not have the power to influence the market price. Likewise, the products that firms sell are perfectly substitutable, which means none of the firms can raise the price of their product above the price of other firms. Doing so might result in a significant number of losses. Lastly, there is a low barrier to entry and exit meaning that there is the elimination of particular expenses that would make it challenging for a new company to enter a market and start producing, or to exit if it cannot generate a profit.
- In a perfectly competitive market, the firms are price takers, sell identical products and operate in a market with low entry and exit barriers.
Now, let us learn about the short-run supply curve.
What might be the basic cost while operating the firm? Land, machinery, labor, and other various fixed and variable costs. When the firm is in its initial stages, it is very difficult for them to cover every cost incurred during the business operations. From fixed costs to variable costs, it becomes a large sum of money that is not possible to cover by the firm. In this situation, what the firm does is, only try to cover the variable costs of the business in the short run. Hence, the marginal cost of a firm at every point above the lowest average variable cost forms the short-run supply curve.
Perfect competition is a market model in which several firms are direct competitors of one another, produce identical goods, and operate in a market with low entry and exit barriers.
The marginal cost of a firm at every point above the lowest average variable cost forms the short-run supply curve.
We have covered the Perfectly Competitive Market in detail. Please don't hesitate to check it out!
Short Run Supply Curve in Perfect Competition
Now, let us look at the short-run supply curve in perfect competition.
A short run is a period when a firm has a fixed amount of capital and adjusts its variable inputs to maximize its profits. In the short run, it is very challenging for a firm to even cover its variable costs. To cover the variable cost, the firm must ensure the total revenue earned is equal to its total variable cost.
\(\hbox{Total Revenue (TR)}=\hbox{Total Variable Cost (TVC)}\)
Further, let us clarify the short-run supply curve in perfect competition by using a diagram.
Fig. 1 - Short-run supply curve in perfect competition
Figure 1 illustrated above is of a short-run supply curve under perfect competition, where the x-axis is output and the y-axis is the price of the product or service. Likewise, curve AVC and AC denotes average variable cost and average cost respectively. Curve MC denotes the marginal cost and MR stands for marginal revenue. Lastly, E is the point of equilibrium.
In Figure 1 the region OPES is the total revenue (TR) as well as the total variable cost (TVC) which indicates that the firm can cover its variable cost through its earned revenue.
For example, you own a chocolate factory and have incurred a variable cost of $1000 and your firm also has a total revenue of $1000 by selling those chocolates. This indicates that your firm can cover its variable cost with the revenue it generates.
You've learned so much! Great Job!Why not learn more about perfect competition?Check out the following articles:- Perfectly Competitive Firm;- Demand Curve in Perfect Competition
Deriving the Short-Run Supply Curve
Now, let us look at the derivation of the short-run supply curve.
Fig. 2 - Deriving the short-run supply curve
In Figure 2, MR under perfect competition is the current market demand. When the demand for the product increases, the MR line shifts upwards to MR1, simultaneously increasing the price of the product from P to P1. Now, the most sensible thing for the firm to do during this situation is to increase its output.
Fig. 3 - Deriving the short-run supply curve
When the output is increased, the new equilibrium point E1 is formed at the new price level P1. The newly formed area OP1E1S1 is greater than the previous area - OPES, which means that the firm can increase its output when the market demand and price level increase.
The distance between equilibrium E and new equilibrium E1 is the short-run supply curve of the firm under perfect competition.
Deriving the Short-Run Supply Curve: Shutdown Situation
Firms might have to face various unforeseeable circumstances while operating, which hinders their ability to sustain themselves. In what situation is the firm forced to shut down? Well, you might have already guessed it.
It occurs when the following holds:
\(\hbox{Total Revenue (TR)}<\hbox{Total Variable Cost (TVC)}\)
Fig. 4 - Shutdown situation
In Figure 4 we can see that the region OPE1S1 which is its total revenue, is unable to cover OPES, which is its total variable cost. Therefore, when the total variable cost is higher than the firm's ability to produce and earn, the firm is forced to shut down.
Let us take the example of the soap manufacturing company. Suppose the company has incurred a variable cost of $1000, but the company has a total revenue of only $800 by selling the manufactured soaps. This means the company will not be able to cover variable costs with the earned revenue.
Short Run Supply Curve Formula
Now, let us learn about the short-run supply curve formula using a graphical representation.
Imagine two firms operating in a perfectly competitive market that produce homogeneous products but have different average variable costs (AVC). As we know, firms in a perfectly competitive market are price takers and have no power to influence the price, they will have to accept the price as given.
Fig. 5 - Short-run supply curve formula
In Figure 5, we can depict that, at price level P, only firm 1 will operate in the market as its AVC will be covered by the revenue it will generate. But firm 2 will not operate at price level P as it will not be able to support its business with the amount of revenue it will generate. This scenario changes when the price of the product increases.
Fig. 6 - Short-run supply curve formula
Now, suppose the price increases from point P to P1. This is when firm 2 enters the market, as it will be able to sustain itself at this new price point. Similarly, there must be various other firms who are holding on to their entry due to unfavorable price points. Once the price increases, they will enter and form the short-run supply curve.
Fig. 7 - Short-run supply curve formula
In Figure 7, we can see the final short-run supply curve of the overall market which is from equilibrium point E to E1, where many firms enter the market according to their favorable circumstance. Hence, many individual firms' supply curves in the short run are combined to calculate the supply curve of the overall market in the short run.
Difference between the Short Run and Long Run Supply Curves
Now, let us look at the difference between the short-run and long-run supply curves.
In contrast to the short run, the long run is a period in which many firms enter and exit the market, causing price changes. This makes it difficult to determine the shape of the long-run supply curve.
In the short run, the firm's principal goal is to cover only the variable costs of the business because it is extremely difficult for them to cover all expenditures incurred during commercial operations. In the long run, the firm attempts to cover all of its operational costs while also making a considerable profit.
In the long run, the firm is also accountable for providing returns to its shareholders, thus they strive to maximize profits.
- Difference between the short-run supply curve and long-run supply curve.
| Short-run supply curve | Long-run supply curve |
| 1. The limited number of firms enter and exit the market. | 1. Numerous firms enter and exit the market. |
| 2. Primary goal is to cover variable costs. | 2. Primary goal is to maximize profits. |
Short Run Supply Curve - Key Takeaways
- Perfect competition is a model of the market where various firms are each other’s direct competitors, produce identical goods, and operate in a market with low entry and exit barriers.
- The marginal cost of a firm at every point above the lowest average variable cost is known as the short-run supply curve.
- To ensure the firm is sustainable in the short run, the firm must make sure the total revenue earned is equal to its total variable cost.
- The firm is at the shutdown point when: \[\hbox{Total Revenue (TR)}<\hbox{Total Variable Cost (TVC)}\]
- In the short run, the firm's principal goal is to cover only the variable costs of the business, whereas, in the long run, the firm attempts to cover all of its operational costs while also making a considerable profit.
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