We're going to take what we understand about the individual firm supply curve.
We had constructed that supply curve by recognizing that
the individual firm with
its marginal cost curve will maximize
profits by setting marginal revenue equals marginal costs.
Marginal revenue equals marginal cost,
and the marginal revenue is a curve that is essentially
a horizontal line at whatever the current market price
is coming from the market generating process.
For example, a Board of Trade sets the price of corn and
corn farmer would take that as the price and operate accordingly.
Now, for different possible prices I might call out,
the firm goes to where marginal revenue equals marginal cost as long as
we're at or above our U-shaped average variable cost curve,
and that means that we can construct
a short run supply curve for the firm as that portion of the marginal cost curve,
at or above the average variable cost.
Now, that means I can construct the market supply as the aggregation.
So, think about it.
Suppose this is firm one.
There's a little supply curve for firm one,
but there's also a different supply curve for firm two,
and it might be a little bit steeper, it may have a different shape.
Why? Well, maybe the land at this particular farmer is a little bit
less suited to corn than the other one so
the supply curve is going to be a little bit different.
All I need to know is that since it
reflects the upward sloping portion of the marginal cost curve,
it's going to be upward sloping also,
ad I've got a lot of these,
and what I want to do is add them all up for the N firms in the industry there.
Each of these firms is going to have their own little and some of
those we'll put on axis that's got quantity on the horizontal axis.
Price is on the vertical, but notice I've got cap Q now,
and that will be the market supply curve.
So, this is the sum of the marginal cost for the N players in the industry.
That's going to be my market supply curve.
Now, these graphs are a little bit small,
a little bit shaky,
but let's move to something a little bit more detailed and a little bit clearer,
because we're going to have to build something that
economists call side-by-side analysis.
It's a rather elaborate picture,
but you'll see what it is.
On the left-hand panel,
I've got the market output.
You know that because it's the capital Q on the horizontal axis,
market output, and there is our old friend,
the demand curve, and and there's the supply curve.
Now, we recognize that that supply curve is just equal to
the sum of the marginal cost curves over I equals one to N,
the N firms in the industry.
I'm adding all their marginal cost curves up and I have a market supply curve.
On the right-hand panel,
you should note I've got q here.
So, this is the individual firm.
There's a lot of these out there, but I'm just going to only need to show you one.
So, the left-hand panel is market,
the right-hand panel, individual firm.
Individual firm goes to where marginal revenue equals marginal cost.
That's going to be an equilibrium for this firm.
What we want to do is to figure out how
this changes in the market changes the firm's behavior.
We built the material that'll help us to figure this out.
I want to add one last curve to this picture.
I'm going to put the average cost curve on.
This is the average total cost
and I look at this picture and I say," Well, you know what?
There's a lot of information captured in this picture,
there's a lot of information that will help me figure this industry out."
So, the first thing I want to remember is I know earlier we
constructed a rule that said that profit for the firm,
and this is economic profit for the firm,
is equal to total revenue minus total cost.
But I know I can rewrite that as
price times quantity minus average total cost times quantity,
and what that means is that I can factor out of here quantity times the bracket price,
minus average total cost.
It shows us what the size of profit is.
The number of units you produce,
that's Q times the per unit markup,
price minus average total cost.
That will give you your total profit for this operation.
Well, do we have this information?
Sure. Take a look at this.
I know that this vertical gap,
right here, is equal to price minus average total cost.
It's a positive number because price is greater than average total cost.
I know this horizontal bar that's equal to output.
So, if I multiply that horizontal bar by that vertical,
it's basically base times height.
That gives me the area of this rectangle,
and the area of that rectangle is going to be our profit in this situation.
So, positive economic profit?
That's a good world to be in.
Because remember positive economic profit means something really important to us.
Economic profit is different than accounting profit,
because economic profit takes into consideration one of
your cost as your next best alternative.
So, the fact that you're making positive economic profit means that you're making
more money than you would've in any other line of business. It's a good deal.
That's a nice place to be at this situation.
The question is, we need to talk about is this an equilibrium, okay?
Are we in some point called equilibrium?
Because from the very beginning,
we've worried a lot about equilibrium.
Thinking about this course,
thinking about understanding economics as an analyst,
the equilibrium is sort of our fallback comfort zone.
It tells us why people would go there and it sometimes tells us, "No, no.
That's not going to be an outcome. People are actually going to
run from that with their hair on fire."
So, we have to think about is this an equilibrium outcome?
So, the way we're going to think about this.
So, I'm going to put a new page up here and I'm going
to ask about equilibrium conditions.
I've got to make sure and I'll put it in blue.
I'm going to make sure we're talking about,
everybody knows we're talking about the short run.