Individual Supply Curve in the Short Run and Long Run: Videos & Practice Problems

In the short run, a firm will continue to operate as long as the price exceeds the average variable cost (AVC). This means that if the price is greater than the AVC, the firm can cover its variable costs and will choose to produce, even if it incurs losses. The firm's short-run supply curve in a perfectly competitive market is represented by the portion of the marginal cost (MC) curve that lies above the AVC. This indicates that production occurs at any price above the minimum AVC.

When analyzing the firm's decision-making, if the market price is set at a level (let's call it p₁) that is above the AVC, the firm will produce a quantity where marginal revenue (MR) equals marginal cost (MC). This is the optimal production point, as it maximizes profit or minimizes losses. Conversely, if the price falls below the minimum AVC (for example, at p₂), the firm will not produce at all, as it cannot cover its variable costs, leading to a quantity of zero.

The resulting shape of the short-run supply curve reflects these decisions, starting from the minimum AVC and extending upward along the MC curve. This creates a unique supply curve that illustrates the firm's willingness to produce at various price levels, emphasizing the critical relationship between price, AVC, and production decisions in the short run.

In the long run, a firm remains in the market as long as the price (P) is greater than the average total cost (ATC). This condition ensures that the firm can cover its costs and earn a profit. When P exceeds ATC, the firm produces at a quantity where the marginal cost (MC) intersects the marginal revenue (MR), which is the price level. The area between the price level and the ATC represents the firm's profit.

In contrast to the short run, where the focus is on average variable cost (AVC), the long run analysis centers on ATC. The firm will only produce when the price is above the minimum point of the ATC curve. If the price falls below this point, the firm will not produce, leading to an exit from the market. This results in a supply curve that is flat at zero output until it reaches the minimum ATC, after which it follows the upward-sloping portion of the MC curve.

The long run firm supply curve thus has a unique shape: it remains at zero output until the price reaches the minimum ATC, and then it begins to reflect the marginal cost of production. This illustrates how firms adjust their output in response to changes in market prices over time, ensuring they operate efficiently and profitably.