Long term supply curve and economic profit
Understanding the long term supply curve in terms of economic profit. Created by Sal Khan.
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- How do you know which equilibrium price at any time is the one that delivers zero economic profit? Wouldn't any new equilibrium price mean that the producers there have no economic incentive to leave- assuming that relatively high cost producers left the scene when a lower equilibrium price is reached?(19 votes)
- This video covers the case of a Constant Cost Industry, where the industry output doesn't affect the costs of the individual firms (this graph is not shown in the video). An Increasing Cost Industry occurs when an expansion in industry output increases the costs of the individual firm. With a Decreasing Cost Industry, industry expansion drives down firm costs.(3 votes)
- In the real world, how would someone actually determine the demand curve for a good?(15 votes)
- Actual supply and demand are based on judgement and calculations. For example, a grocery store runs out of powdered milk. So, the store asks the supplier to make them powdered milk. So the supplier lists it down in their "demand" list and totals it up when the year is over. It's done together with the inventorying and accounting. Then, from this, they deduce that they should produce the same amount next year as well. They make actual curves/charts and map the patterns. That is how I see demand and supply in simple terms. I did a very small business before with my sister and this is how we found out what the demand and supply were. For bigger companies, I think they do statistical calculations like probability and so on.(7 votes)
- Isn't the economic profit comparing two business domains to figure out which one is the more profitable to operate in? So when saying econ. profit equals zero, what are we comparing it with?(7 votes)
- Whenever economic profit is zero, all costs are covered by the revenue, both explicit and implicit. This differs from an accounting zero where only the explicit costs are covered.(8 votes)
- At6:45, it seems counter-intuitive that the supply curve will move down as more firms enter the market... I can see how this would be the case for each individual firm (having an increasingly smaller share of the market), but not for the industry curves. Is this a model of both the industry AND an individual firm?(2 votes)
- The Supply and Demand curves presented in the video are market curves. And one of the factors affecting the market curve is the number of participants (eg number of sellers for the market supply curve). So additional sellers will increase Supply (shift the curve down).(3 votes)
- Wouldn't Supply Curve SHIFT to right in the long term in case of increase in orange demand, and SHIFT to left in case of decrease in demand. If yes, then why is Sal talking about 'Quantities' here, or in other words, about the movement along the curve...?(4 votes)
- Even if demand rises or falls, production costs remain the same (which is why it moves along the curve instead of moving the curve).
Moving the curve left or right means you are willing to produce less or more at the same market price.(1 vote)
- Would it be fair to say that the supply is basically perfectly elastic on the long run?(2 votes)
- Yes, for a single firm, we can pretty much say that supply is perfectly elastic in the long run. This is because we assume that factors of production, in the long run, can easily be moved between firms and different industries.(3 votes)
- At5:40, why does the price raise?
(And why does it fall back to 50ct/gallon after it was raised by the study?)
Shouldn't the supply fall back to a point where the equilibrium of now 40ct/gallon (in the first scenario) is reached and stay at this point until the demand changes?
If seen as a completely new market situation the history of the market in this simplified model should have no effect on the current price, as there is now a equilibrium price at 40ct/gallon.
The only reasons I could make up for a raising price is either a overcompensation of the supplying companies, meaning a higher cut in supply so the demand isn't covered anymore (meaning a short term price increase) or a vanishing effect of the study.(1 vote)
- In the first scenario, the price goes back to $0.50/gal because suppliers are not making any economic profit with the price at $0.40/gal, so they will exit the market altogether, resulting in a decrease in supply, causing the price to increase again. In the second scenario, the opposite happens. Suppliers are making a decent economic profit, so new suppliers enter the market, causing supply to increase, which results in a decrease in price.(3 votes)
- In my school my professor taught us that the Long Run supply curve is a Vertical Line?
Can someone help me out?(2 votes)
- This means he is taking a new classical approach. He assumes that in the long-run, there is a full level of employment and thus the production is maximised (productive efficiency is achieved).(1 vote)
- at2:07, I am not very clear as to how the supply curve is also the MC curve?(2 votes)
- Marginal Cost is the cost to produce an additional item. At some point, there are diminishing returns and would not be economically efficient to make another one. The supply curve is different. The supply curve is the affect of an increase in supply by the manufacturer. If the price of a product increases, it encourages suppliers to produce more. If supply is greater than demand, prices will decrease.(1 vote)
- if I'm losing as much money as I'm making (i.e, when economic profit is zero), what is the point of being in business? Why should I continue if I am making no profit?(1 vote)
- You are probably making money, but it is just as much as you would be making by devoting your resources to another project. In other words, you are indifferent between doing this and some other project.(3 votes)
Voiceover: We've now thought a lot about the orange juice market, at least at a firm-specific level within the last few videos. We talked about what our average total costs and average variable costs and marginal costs are, if we are running an orange juice making business. Now let's think about what happens at the market level. We're going to go back to some of what we've thought about in the past in terms of just supply and demand curves. This is the orange juice, orange juice market, and let's just draw some supply and demand curves right over here. This is going to be, this is going to be the price per gallon, price per gallon, and let's say that this right over here is $1. This right over here is 50 cents, and this is 0, and let's say that this is the quantity, quantity, quantity in gallons per week, and gallons per week. We're going to talk about the entire orange juice market, so this is going to be in millions of gallons per week. Millions of gallons per week, per week. That is, let's say this is 1, 2, 3, 4, 5, and 6. Let's just say, and I'm going to simplify it relative to what we saw in the last video. Let's just say that the supply curve for the orange juice market, and I'll be careful this time. This is the near-term supply curve, or the short-term supply curve, looks like, looks something like this. that is the supply curve. This is the entire market. These are all of the orange juice producers. So to get them to produce even that first gallon, it looks like they need about 20 cents for that first gallon, and then each incremental gallon, they need more and more money. The marginal cost of that incremental gallon and for the market as a whole is going higher and higher and higher. They have to get oranges from futher away and transport them further and further. This right over here is the supply curve, or you could view it as the marginal cost, marginal cost curve. Now let's just draw an arbitrary demand curve here. The demand curve, let's say it looks something like this. Let's say that's our current demand, that is our current demand curve, and then what I'm going to add to this is I'm going to add the price at which firms, the suppliers of the orange juice make are neutral with returns to economic profit, or when economic profit is equal to 0. Let's say right over here, which happens to be our current equilibrium price, this is the price, so 50 cents per gallon, this is the price at which economic profit is 0. so I'll just write economic profit is equal to 0. I want to remind you, economic profit being 0 does not mean that the accounting profit is 0. People could be making money at this price, it just says that they're neutral whether or not they should be doing this business. That the amount of money that they're making is roughly comparable to their opportunity cost to be doing other things. When I say economic profit is 0, sometimes that's called the normal profit, when economic profit is 0. This is the price at which people are neutral between shutting down and starting up their business. If you have positive economic profit, that means that more people will want to go into this market and if you have negative economic profit, that means that people are going to want to essentially use up their fixed expenses, their equipment and any labor contracts they might have and then go out of business. This is where, this is that point right over there. Now let's think of a couple of scenarios. Let's say a research paper comes out and in that research paper, for whatever reason, we don't know if it was well-done research. It says oranges are bad for you, for whatever reason. When the research paper comes out and says oranges are bad for you, what happens to demand? Well, at any given price, demand will go down. At any given price, demand will go down, and the new demand curve might look something like this. Now, in the near term, we have a new equilibrium price, and we have a new equilibrium quanitity. This was the old equilibrium price, the way I set that up, it just happened to be the price at which economic profit is 0, and this was our old equilibrium quantity, a little over 3 million gallons a week. Now we have a new, lower equilibrium price. We have a new lower equilibrium price. I don't know, this looks about 40 cents per gallon, and we have a new lower equilibrium quantity. Now, what happens at this price? Obviously in the near term, people are willing to produce there because that's where their marginal cost is, so, as we saw in multiple videos that someone's willing to produce when the price is equal to their marginal cost, or they're willing to produce a quantity up to when their marginal cost is equal to the marginal revenue, or the price that they're going to get. But, I just said that they need to be getting 50 cents a gallon in order to make an economic profit. Now if they get, I don't know, this looks like about 40 cents a gallon, they're going to be having an economic loss. So no profit. No profit there. If there's no profit there, it really doesn't make sense for them to continue, or at least it doesn't make sense for all of them to continue in that business. What's going to happen is that over time, it will make sense for them in the near term to produce, to use up, they've already put in their cost for their equipment and maybe labor contracts and whatever else. But over time, when prices are this low, as people use up their equipment, there's no incentive for them to buy new equipment. As the labor contracts expire, there's no incentive for them to renew the labor contract. As those things expire, they're just going to shut down the business. So as they shut down the business, as they shut down the business, two things will happen. Quantity produced in the market will go down, and the price will go up. We will essentially move along this curve until we get to this point. That's the point, once the price is at 50 cents a gallon again, then people are neutral now. They're not going to shut down their firms. We're going to get to this new equilibrium price and equilibrium quantity in the long term, in the long term. Now let's think of another situation. Instead of a newspaper report saying that oranges are bad, let's say a newspaper report comes out saying oranges are very good. They make you live longer. They are the best thing that you can have. Well, then, at any given price, you're going to have more demand, and so you'd have a demand curve that looks something like that. Then, you'd have a higher equilibrium quantity, and a higher equilibrium price. And, people are going to be making, since the price is higher, than the price at which the economic profit is 0, people are going to be making very positive economic profits, which means that there's a strong incentive, that people are neutral between shutting down the business or starting up the business. At that point, a lot of people are strongly motivated to enter into the business. What's going to happen is, more and more people are going to get more and more equipment, hire more and more people, and as they do that, quantity is going to go up, and the price is going to go down. And so, over the long term, you're going to shift back to this line. Once the price gets down to that, then there's no reason for more people to enter. They're kind of neutral about it. What you see happening is in the short term, you would look at where the demand curve intersects with the short-term supply curve, but in the long term, you care where it intersects with this kind of horizontal line, which is the price at which economic profit is 0. That's why you will hear, and this is kind of a more precise way of thinking about it than we've done in the previous videos, this horizontal line right over here, you could view this as the long run, the long run, long run supply curve, long run supply curve. That says look, pretty much whatever we will always produce over the long run, we will always produce whatever supply is kind of necessary, given that people are neutral when it comes to economic profit. You go down here, yes, people will try to use up their fixed costs, but once they used up their fixed costs, no incentive for them to stay in business, then some of them go out of business. Price goes up, quantity goes down. You get back to the long run supply curve, where that intersects with the demand curve, or if the opposite happens. A lot of economic profit, a lot of entrance into the market, price goes down, supply goes up. You get back to the long run supply curve. I guess you could say, you could go back to where the new demand curve is intersecting the long run supply curve.