Short Run Supply Curve

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.

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.

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.

• 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.