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Industry supply in the short run

15 February, 2016 - 09:58

In The classical marketplace – demand and supply it was demonstrated that individual demands can be aggregated into an industry demand by summing them horizontally. The industry supply is obtained in exactly the same manner—by summing the firms’ supply quantities across all firms in the industry.

To illustrate, imagine we have many firms, possibly operating at different scales of output and therefore having different short-run MC curves. The MC curves of two of these firms are illustrated in Figure 9.3. The MC of A is below the MC of B; therefore, B likely has a smaller scale of plant than A. Consider first the supply decisions in the price range P_1 to P_2. At any price between these limits, only firm A will supply output – firm B does not cover its AVC in this price range. Therefore, the joint contribution to industry supply of firms A and B is given by the MC curve of firm A. But once a price of P_2 is attained, firm B is now willing to supply. The S_{sum} schedule is the horizontal addition of their supply quantities. Adding the supplies of every firm in the industry in this way yields the industry supply.

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Figure 9.3 Deriving industry supply 

At any price below P_1 production is unprofitable and supply is therefore zero for both firms. At prices between P_1 and P_2 firm A is willing to supply, but not firm B. Consequently the market supply comes only from A. At prices above P_2 both firms are willing to supply. Therefore the market supply is the horizontal sum of each firm’s supply.

\mid Industry supply (short run) in perfect competition is the horizontal sum of all firms’ supply curves.

\mid Short run equilibrium in perfect competition occurs when each firm maximizes profit by producing a quantity where P = MC.