Entry, Exit, and Supply Curves: Constant Costs
-
0:00 - 0:06♪ [music] ♪
-
0:10 - 0:12- [Alex] Okay -- this talk is going
to be a bit more involved. -
0:12 - 0:16What we're going to show
is how a constant cost industry -
0:16 - 0:19generates a flat supply curve.
-
0:19 - 0:21Let's begin.
-
0:25 - 0:28A constant cost industry
is one where it's very easy -
0:28 - 0:32to expand output
without pushing up costs. -
0:32 - 0:36So for example, pencils, rutabagas,
domain name registration -- -
0:36 - 0:38these are all constant cost
industries. -
0:38 - 0:40Think about pencils.
-
0:40 - 0:43We can easily increase
the supply of pencils -
0:43 - 0:47by quite a bit without pushing up
the cost of producing pencils. -
0:47 - 0:51Why not? Well, what do we need
to produce more pencils? -
0:51 - 0:53We need more wood,
we need more graphite, -
0:53 - 0:54we need more rubber.
-
0:54 - 0:58However, we'd need
just a little bit more wood -
0:58 - 1:00relative to the total
world supply of wood. -
1:00 - 1:03Just a little bit more graphite
relative to the world supply -
1:03 - 1:04of graphite.
-
1:04 - 1:07And just a little bit more rubber
relative to the world supply -
1:07 - 1:08of rubber.
-
1:09 - 1:13In other words, we can increase
the number of pencils produced, -
1:13 - 1:17but only increase the demand
for the inputs by a small -
1:17 - 1:19and non-appreciable amount.
-
1:19 - 1:22We're not going to be pushing up
the price of wood, for example, -
1:22 - 1:25when we produce more pencils.
-
1:25 - 1:28The story would be different
if it was housing. -
1:28 - 1:31If 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 -
1:34 - 1:35the price of wood up.
-
1:35 - 1:39As we'll see, that would correspond
to an increase in cost industry. -
1:40 - 1:42What about rutabagas?
Again, the idea's the same. -
1:42 - 1:46We can easily increase
the supply of rutabagas by a lot -
1:46 - 1:49without increasing
the price of the input, -
1:49 - 1:51such as land or fertilizer.
-
1:51 - 1:55Rutabagas are simply too small
a portion of the market -
1:55 - 1:57for land or the market
for fertilizer -
1:57 - 2:01to have an appreciable effect
on the price of these inputs, -
2:01 - 2:04even if we were to increase
the supply of rutabagas by a lot. -
2:05 - 2:08Same thing with domain name
registration. -
2:08 - 2:12As the internet has expanded,
tremendously, it still costs -
2:12 - 2:15about six or seven dollars
to register a domain name, -
2:15 - 2:17since it's very cheap to do that
-
2:17 - 2:20with just a few additional
computers. -
2:20 - 2:22A little bit more
computer resources -- -
2:22 - 2:25very small portion
of the total number of computers -- -
2:25 - 2:28and we can increase the supply
of domain name registrars -
2:28 - 2:30very, very easily.
-
2:31 - 2:35The implication of all this
is that long run supply curves -
2:35 - 2:38for these goods, for goods
like pencils, rutabagas, -
2:38 - 2:41and domain name registration,
the long run supply curve -
2:41 - 2:43is going to be flat.
-
2:43 - 2:46Let's take a closer look
with a diagram. -
2:46 - 2:48So in this diagram,
we're going to show -
2:48 - 2:51how a constant cost industry
adjusts to a shift -
2:51 - 2:54in increase in demand.
-
2:54 - 2:57And in so doing, we'll in fact show
why it's a constant cost industry. -
2:58 - 3:01We're going to do so by looking
at two things simultaneously: -
3:01 - 3:04the market
and the representative firm. -
3:04 - 3:06So there are lots of firms
in this industry -
3:06 - 3:08and we're going to pick
just one of them -
3:08 - 3:09to represent them all.
-
3:09 - 3:11Now we're going to begin
with the market side, -
3:11 - 3:13with which we're very familiar.
-
3:13 - 3:17Here is our demand curve and here
is our short run supply curve. -
3:18 - 3:21The quantity demanded is equal
to the quantity supplied -- -
3:21 - 3:24that determines our initial
or short run equilibrium. -
3:24 - 3:27In fact, this is also going
to be the long run equilibrium -
3:27 - 3:30for reasons
which will become clear. -
3:30 - 3:33Now we also want
the representative firm -
3:33 - 3:35to be in equilibrium.
-
3:35 - 3:38So the firm is profit maximizing,
so that means the price -
3:38 - 3:40is going to be equal
to marginal cost. -
3:40 - 3:43And in addition,
price will be equal -
3:43 - 3:47to average cost, because the firm
is going to be earning normal, -
3:47 - 3:50or zero economic profits.
-
3:50 - 3:51Normal profits.
-
3:51 - 3:54So this is our initial equilibrium
for the market side -- -
3:54 - 3:57quantity demanded is equal
to the quantity supplied. -
3:57 - 4:00And on the firm side,
price is equal to marginal cost, -
4:00 - 4:03so firms are profit maximizing,
and price is equal -
4:03 - 4:07to average cost, so profits
are normal or zero. -
4:08 - 4:11Okay, now let's look
at what happens -
4:11 - 4:13when we increase demand.
-
4:13 - 4:15Two things are going to happen
on the market side -- -
4:15 - 4:17of course the demand curve
will shift out pushing up the price -
4:17 - 4:19to a new equilibrium.
-
4:19 - 4:22On the firm side,
as the price goes up -
4:22 - 4:25the firm will be expanding
along its marginal cost curve. -
4:25 - 4:28Let's look at the market --
both of these things -
4:28 - 4:29are going to happen
simultaneously -- -
4:29 - 4:31let's look at what happens
in the market -
4:31 - 4:34and then we'll do it again to focus
on the representative firm. -
4:34 - 4:37So here we go --
an increase in demand -- -
4:37 - 4:41the price shifts up,
we come to a new equilibrium -
4:41 - 4:46at point B on the market side,
and as I said each firm expands -
4:46 - 4:50along its marginal cost curve
so we have a new equilibrium -
4:50 - 4:53for the representative firm,
also at point B. -
4:53 - 4:55Now in case you missed it,
let's show that again. -
4:55 - 4:57For the representative firm,
looking now -
4:57 - 4:58at the representative firm.
-
4:59 - 5:01Now looking
at the representative firm, -
5:01 - 5:05here is the increase in demand --
it drives price up -
5:05 - 5:09as it does so each firm expands
along its marginal cost curve. -
5:09 - 5:13In fact, the reason
why the supply curve -
5:13 - 5:17in the short run is upward sloping
is precisely that each firm -
5:17 - 5:20currently in the industry
is expanding -
5:20 - 5:24as price increases
along its marginal cost curve. -
5:24 - 5:26By the short run,
what we actually mean, -
5:26 - 5:30is the time period before new firms
have a chance to enter -
5:30 - 5:32into the industry.
-
5:32 - 5:36So the entire increase in supply
in the short run is being driven -
5:36 - 5:41by the increased output
of currently existing firms -
5:41 - 5:46as they expand to take advantage
of the increase in price. -
5:47 - 5:51Now notice that initially,
the representative firm -
5:51 - 5:55was making zero economic profit,
it was making normal profits. -
5:55 - 5:58With the increase in demand,
they're making positive, -
5:58 - 6:00above normal profits.
-
6:00 - 6:04Remember profit is price
minus average cost times quantity. -
6:04 - 6:07So profit here is positive,
it's above normal. -
6:07 - 6:11And those above normal profits
are going to attract other firms. -
6:11 - 6:14Other firms are going to say,
"I want a piece of the action. -
6:14 - 6:16I want a piece of the pie."
-
6:16 - 6:19Remember when price
is above average cost, -
6:19 - 6:22that's when new firms
enter into the industry. -
6:23 - 6:25So what is that entry going to do?
-
6:25 - 6:27Well, it's going to do two things.
-
6:27 - 6:29On the market side,
it's going to shift out -
6:29 - 6:31the short-run supply curve.
-
6:31 - 6:33It's going to shift
the short-run supply curve -
6:33 - 6:38to the right, and as that happens,
price is going to be pushed down. -
6:38 - 6:42As price is pushed down,
each firm will contract -
6:42 - 6:46along its marginal cost curve,
profits falling all the way -
6:46 - 6:47until we reach a point
-
6:47 - 6:50of normal economic profits
once again. -
6:50 - 6:52So let's show this again,
we'll show it twice, -
6:52 - 6:54first of all we can look
at the market side -
6:54 - 6:56and then we'll look
at the representative firm. -
6:56 - 7:00So, profits in the short run
are going to attract new entry. -
7:00 - 7:02As we get new entry,
the supply curve -
7:02 - 7:05in the short run expands,
shifts outward, -
7:05 - 7:07pushing down the price
until we reach -
7:07 - 7:10a new long run equilibrium
which is here -
7:10 - 7:14and until profits
are zero over here. -
7:14 - 7:17Again, now let's look at this again
for the representative firm. -
7:17 - 7:20Okay here's the representative firm
on the right. -
7:20 - 7:22As profits attract entry
-
7:22 - 7:24entry is going to push
price down and here we go, -
7:24 - 7:26let's see what happens.
-
7:26 - 7:28As the price goes down,
each firm contracts -
7:28 - 7:29along its marginal cost curve.
-
7:29 - 7:33In fact, we can now see why
the long run cost curve is flat. -
7:34 - 7:38Because we begin at point A
at the minimum point -
7:38 - 7:43of the average cost curve,
and we end at point C, -
7:43 - 7:46here's point C, which is also
at the minimum point -
7:46 - 7:48of the average cost curve.
-
7:48 - 7:53So the long run supply curve
is flat at the minimum point -
7:53 - 7:54of the average cost curve.
-
7:55 - 7:59Now where does our assumption
of constant industry cost come in? -
7:59 - 8:00It comes in right here.
-
8:00 - 8:04Because the idea is that
when the industry expands -
8:04 - 8:08with new entry,
that isn't driving up -
8:08 - 8:10the representative firm's costs.
-
8:10 - 8:14And the reason that is,
is that this industry is small -
8:14 - 8:17relative to its input markets.
-
8:17 - 8:20So when this industry expands,
it doesn't drive up the price -
8:20 - 8:21of its inputs.
-
8:21 - 8:24That means that this average
cost curve isn't changing -
8:24 - 8:28as the industry expands
or contracts. -
8:28 - 8:31Because this cost curve
for the representative firm -
8:31 - 8:34isn't changing,
the only equilibrium -
8:34 - 8:37with zero economic profit
is at the minimum point, -
8:37 - 8:40is when price is equal
to average cost. -
8:40 - 8:43So that's always going to,
price is going to be driven down -
8:43 - 8:47in the long run to the minimum
of this average cost curve, -
8:47 - 8:50to the point where
there's zero economic profits. -
8:50 - 8:55So A and C are along a long-run
industry supply curve, -
8:55 - 8:57which is flat.
-
8:57 - 9:00All right, that's
a huge amount to take in. -
9:00 - 9:03Let's just go over it briefly
using this diagram. -
9:04 - 9:08We began with an initial
equilibrium at point A, -
9:08 - 9:11an increase in demand
pushed us in the short run -
9:11 - 9:15to point B, where each firm
was making positive profits. -
9:16 - 9:20Those profits attracted new firms
into the industry. -
9:20 - 9:23Those new firms shifted
to the right, -
9:23 - 9:26the short-run supply curve,
pushing prices down -
9:26 - 9:30until we reach a new point
of long-run equilibrium. -
9:30 - 9:33That new point
of long-run equilibrium -
9:33 - 9:35is precisely when we're
back to zero -
9:35 - 9:38or normal economic profits
at the minimum point -
9:38 - 9:40of the average cost curve.
-
9:40 - 9:44The average cost curve
isn't shifting because input prices -
9:44 - 9:48aren't changing as this industry
expands or contracts, -
9:48 - 9:51and that's why
the long-run supply curve is flat. -
9:52 - 9:55Whew! All right.
That was a lot. What else? -
9:56 - 9:59So we've now shown how an increase
in cost industry leads -
9:59 - 10:01to an upward sloped supply curve.
-
10:01 - 10:03A constant cost industry leads
-
10:03 - 10:05to a flat or horizontal
supply curve. -
10:05 - 10:09And we're about to show
how a decreasing cost industry, -
10:09 - 10:12the unusual case, leads
to a downward sloped supply curve, -
10:12 - 10:14at least over some range.
-
10:14 - 10:16Let's do that next.
-
10:17 - 10:18- [Narrator] If you want
to test yourself, -
10:18 - 10:20click "Practice Questions,"
-
10:20 - 10:24or if you're ready to move on,
just click, "Next Video." -
10:24 - 10:28♪ [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
Ask a question about the video: http://mruniversity.com/courses/principles-economics-microeconomics/supply-curve-constant-cost-industry#QandA
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 |