Entry, Exit, and Supply Curves: Constant Costs
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0:00 - 0:03♪ [music] ♪
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0:09 - 0:14- Okay - this talk is going to be a bit more
involved. What we're going to show is how -
0:14 - 0:25a constant cost industry generates a flat
supply curve. Let's begin. -
0:25 - 0:30- A constant cost industry is one where
it's very easy to expand output without -
0:30 - 0:36pushing up costs. So for example, pencils,
rutabagas, domain name registration - these -
0:36 - 0:41are all constant cost industries. Think
about pencils. We can easily increase the -
0:42 - 0:47supply of pencils by quite a bit without
pushing up the cost of producing pencils. -
0:48 - 0:52Why not? Well, what do we need to produce
more pencils? We need more wood, we need -
0:52 - 0:57more graphite, we need more rubber.
However, we'd need just a little bit more -
0:57 - 1:02wood relative to the total world supply of
wood. Just a little bit more graphite -
1:02 - 1:06relative to the world supply of graphite.
And just a little bit more rubber relative -
1:06 - 1:11to the world supply of rubber. In
other words, we can increase the number of -
1:12 - 1:18pencils produced, but only increase the
demand for the inputs by a small and -
1:18 - 1:21non-appreciable amount. We're not going
to be pushing up the price of wood, for -
1:21 - 1:27example, when we produce more pencils. The
story would be different if it was -
1:27 - 1:31housing. If we want to produce more
housing, that's a big demander of wood. -
1:31 - 1:34That would require a lot more wood and
could potentially push the price of wood -
1:35 - 1:40up. As we'll see, that would correspond
to an increase in cost industry. What -
1:40 - 1:44about rutabagas? Again, the idea's the
same. We can easily increase the supply of -
1:44 - 1:50rutabagas by a lot without increasing the
price of the input, such as land or -
1:50 - 1:55fertilizer. Rutabagas are simply too small
a portion of the market for land or the -
1:56 - 2:00market for fertilizer to have an
appreciable effect on the price of these -
2:00 - 2:04inputs, even if we were to increase
the supply of rutabagas by a lot. -
2:04 - 2:06Same thing
with domain -
2:06 - 2:12name registration. As the internet has
expanded, tremendously, it still costs -
2:12 - 2:16about six or seven dollars to register a
domain name, since it's very cheap to do -
2:16 - 2:22that with just a few additional computers.
A little bit more computer resources - very -
2:22 - 2:26small portion of the total number of
computers - and we can increase the supply -
2:26 - 2:33of domain name registrars very, very
easily. The implication of all this is -
2:33 - 2:38that long run supply curves for these
goods, for goods like pencils, rutabagas -
2:38 - 2:43and domain name registration, the long run
supply curve is going to be flat. Let's -
2:44 - 2:48take a closer look with a diagram. So in
this diagram we're going to show how a -
2:48 - 2:54constant cost industry adjusts to a shift
in increase in demand. And in so doing, -
2:54 - 2:59we'll in fact show why it's a constant
cost industry. We're going to do so by -
2:59 - 3:04looking at two things simultaneously: the
market and the representative firm. So -
3:04 - 3:07there are lots of firms in this industry
and we're going to pick just one of them -
3:07 - 3:11to represent them all. Now we're going to
begin with the market side, with which -
3:11 - 3:16we're very familiar. Here is our demand
curve and here is our short run supply -
3:17 - 3:22curve. The quantity demanded is equal to
the quantity supplied - that determines our -
3:22 - 3:26initial or short run equilibrium. In fact,
this is also going to be the long run -
3:26 - 3:32equilibrium for reasons which will become
clear. Now we also want the representative -
3:32 - 3:37firm to be in equilibrium. So the firm is
profit maximizing, so that means the -
3:38 - 3:43price is going to be equal to marginal
cost. And in addition, price will be equal -
3:43 - 3:48to average cost, because the firm is going
to be earning normal, or zero economic -
3:49 - 3:53profits. Normal profits. So this is our
initial equilibrium for the market side - -
3:54 - 3:59quantity demanded is equal to the quantity
supplied. And on the firm side, price is -
3:59 - 4:01equal to marginal cost,
so firms are profit -
4:01 - 4:07maximizing, and price is equal to average
cost, so profits are normal or zero. -
4:07 - 4:13Okay, now let's look at what happens
when we increase demand. Two things -
4:13 - 4:16are going to happen on the market side -
of course the demand curve will shift out -
4:16 - 4:21pushing up the price to a new equilibrium.
On the firm side, as the price -
4:21 - 4:26goes up the firm will be expanding along
its marginal cost curve. Let's look at the -
4:27 - 4:30market - both of these things are going to
happen simultaneously - let's look at what -
4:30 - 4:33happens in the market and then we'll do
it again to focus on the representative -
4:33 - 4:40firm. So here we go - an increase in demand -
the price shifts up, we come to a new -
4:40 - 4:47equilibrium at point B on the market side,
and as I said each firm expands along its -
4:47 - 4:51marginal cost curve so we have a new
equilibrium for the representative firm, -
4:52 - 4:55also at point B. Now in case you missed
it, let's show that again. For the -
4:56 - 4:59representative firm, looking now at the
representative firm. Now looking at the -
5:00 - 5:06representative firm, here is the increase
in demand - it drives price up as it does so -
5:06 - 5:12each firm expands along its marginal cost
curve. In fact, the reason why the supply -
5:12 - 5:17curve in the short run is upward
sloping is precisely that each firm -
5:18 - 5:23currently in the industry is expanding as
price increases along its marginal cost -
5:23 - 5:29curve. By the short run, what we actually
mean, is the time period before new firms -
5:29 - 5:34have a chance to enter into the industry.
So the entire increase in supply in the -
5:34 - 5:42short run is being driven by the increased
output of currently existing firms as they -
5:42 - 5:50expand to take advantage of the increase
in price. Now notice that initially, the -
5:50 - 5:54representative firm was making zero
economic profit, it was making normal -
5:54 - 5:59profits. With the increase in demand,
they're making positive, above normal -
5:59 - 6:00profits.
Remember profit is -
6:00 - 6:06price minus average cost times quantity.
So profit here is positive, it's above -
6:06 - 6:12normal. And those above normal profits are
going to attract other firms. Other firms -
6:12 - 6:16are going to say, "I want a piece of the
action. I want a piece of the pie." -
6:16 - 6:21Remember when price is above average cost,
that's when new firms enter into the -
6:21 - 6:26industry. So what is that entry going to
do? Well, it's going to do two things. On -
6:26 - 6:31the market side, it's going to shift out
the short-run supply curve. It's going to -
6:31 - 6:36shift the short-run supply curve to
the right, and as that happens, price is -
6:36 - 6:42going to be pushed down. As price is
pushed down, each firm will contract along -
6:42 - 6:47its marginal cost curve, profits falling
all the way until we reach a point of -
6:47 - 6:51normal economic profits once again. So
let's show this again, we'll show it -
6:51 - 6:54twice, first of all we can look at the
market side and then we'll look at the -
6:54 - 7:00representative firm. So, profits in the
short run are going to attract new entry. -
7:00 - 7:05As we get new entry, the supply curve in
the short run expands, shifts outward, -
7:05 - 7:10pushing down the price until we reach a
new long run equilibrium which is here -
7:10 - 7:15and until profits are zero over here.
Again, now let's look at this again for -
7:15 - 7:18the representative
firm. Okay here's -
7:18 - 7:22the representative firm on the
right. As profits attract entry, entry is -
7:22 - 7:26going to push price down and here we go,
let's see what happens. As the price goes -
7:26 - 7:30down, each firm contracts along its
marginal cost curve. In fact, we can now -
7:30 - 7:38see why the long run cost curve is flat.
Because we begin at point A at the minimum -
7:38 - 7:45point of the average cost curve, and we
end at point C, here's point C, which is -
7:45 - 7:50also at the minimum point of the average
cost curve. So the long run supply curve -
7:50 - 7:56is flat at the minimum point of the
average cost curve. Now where does our -
7:56 - 8:00assumption of constant industry cost
come in? It comes in right here. -
8:00 - 8:06Because the idea is that when the
industry expands with new entry, that -
8:06 - 8:12isn't driving up the representative firm's
costs. And the reason that is, is that -
8:13 - 8:17this industry is small relative to its
input markets. So when this industry -
8:18 - 8:22expands, it doesn't drive up the price of
its inputs. That means that this average -
8:22 - 8:29cost curve isn't changing as the industry
expands or contracts. Because this cost -
8:29 - 8:34curve for the representative firm isn't
changing, the only equilibrium with zero -
8:34 - 8:39economic profit is at the minimum point,
is when price is equal to average cost. -
8:40 - 8:45So that's always going to, price is going
to be driven down in the long run to the -
8:45 - 8:48minimum of this average cost curve, to
the point where there's zero economic -
8:49 - 8:57profits. So A and C are along a long-run
industry supply curve, which is flat. -
8:57 - 9:02All right, that's a huge amount to take
in. Let's just go over it briefly using -
9:03 - 9:09this diagram. We began with an initial
equilibrium at point A, an increase in -
9:09 - 9:15demand pushed us in the short run to point
B, where each firm was making positive -
9:15 - 9:17profits. Those
profits attracted -
9:17 - 9:22new firms into the industry.
Those new firms shifted to the right, the -
9:23 - 9:29short-run supply curve, pushing prices
down until we reach a new point of long- -
9:29 - 9:34run equilibrium. That new point of
long-run equilibrium is precisely when -
9:34 - 9:38we're back to zero or normal economic
profits at the minimum point of the -
9:38 - 9:44average cost curve. The average cost curve
isn't shifting because input prices aren't -
9:44 - 9:49changing as this industry expands or
contracts, and that's why the long-run -
9:49 - 9:55supply curve is flat. Whew! All right.
That was a lot. What else? -
9:55 - 9:58So we've now
shown how an increase -
9:58 - 10:02in cost industry leads to an upward
sloped supply curve. A constant cost -
10:02 - 10:07industry leads to a flat or horizontal
supply curve. And we're about to show how -
10:07 - 10:12a decreasing cost industry, the unusual
case, leads to a downward sloped supply -
10:12 - 10:15curve, at least over some
range. Let's do that next. -
10:17 - 10:21- [Announcer] If you want to test yourself, click,
"Practice Questions," or if you're ready -
10:21 - 10:24to move on, just
click, "Next Video." -
10:24 - 10:27♪ [music] ♪
- Title:
- Entry, Exit, and Supply Curves: Constant Costs
- Description:
-
Some industries have a flat supply curve. These are called constant cost industries. Take domain name registration, to increase the supply of domain names, we must only increase the inputs by a negligible amount. That is why even as the internet expands so rapidly, it still costs only about $6 or $7 dollars to register a new domain name. By showing you how these industries respond to an increase in demand, we can explain why it’s a constant cost industry.
Microeconomics Course: http://mruniversity.com/courses/principles-economics-microeconomics
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Next video: http://mruniversity.com/courses/principles-economics-microeconomics/supply-curve-decreasing-cost-industry
- Video Language:
- English
- Team:
- Marginal Revolution University
- Project:
- Micro
- Duration:
- 10:29
Martel Espiritu edited English subtitles for Entry, Exit, and Supply Curves: Constant Costs | ||
Martel Espiritu edited English subtitles for Entry, Exit, and Supply Curves: Constant Costs | ||
Martel Espiritu edited English subtitles for Entry, Exit, and Supply Curves: Constant Costs | ||
MRU2 edited English subtitles for Entry, Exit, and Supply Curves: Constant Costs | ||
MRU2 edited English subtitles for Entry, Exit, and Supply Curves: Constant Costs |