Topic 6 - Perfectly Competitive Supply : The Cost Side of the Market and Production in the Short-run

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Perfectly Competitive Supply: The Cost Side of the Market And Production in the Short Run

Opportunity Cost And the Supply Curve

The supply curve represents the marginal cost curve (includes opportunity costs) and the sellers reservation price in a market.

Supply Curve Example

This example [1] is based upon Harry's ability to collect/supply cans. As he spends more time collecting cans it becomes harder to find others which is why marginal cans diminished.

Harry can sell each can for $0.20 and his opportunity cost is $6/hour.


He should continue collecting until marginal revenue = marginal cost (3 hours). He has diminishing marginal increases due to the principle of increasing opportunity costs (harder to find cans).

The Price of the good would have to increase for him to collect for more than 3 hours (he needs more than $6 to continue collecting). This is shown in the diagram below - how many cans he will collect depends on the price.


Individual And Market Supply Curves

The Quantity that corresponds to a particular price on the market supply curve is the sum of all the quantities supplied at that price level by individual sellers in the market.

It is upward sloping:

  • Principle of increasing opportunity costs for individual suppliers
    • people with higher opportunity costs will supply at higher prices


Supply In Perfectly Competitive Markets

The main reason for a firms existence is to maximise profit (revenue - total costs). In perfectly competitive markets firms are price takers and do NOT influence the market price

The assumptions of a perfectly competitive market are:

  1. Standardised product
  2. Many Buyers & Sellers (each individual is only a fraction of market volume – no market power)
  3. No Barriers to Entry/Exit
  4. Well informed Buyers & Sellers

The market demand and supply curves as well as the demand curved FACED by an INDIVIDUAL firm are shown in the image below:


Bottle Company - Comprehensive Example With Theory


  • Factors of Production - inputs e.g. labour and capital
  • Short Run - At least 1 factor cannot be varied (e.g. capital) and at least 1 factor can be varied (e.g. labour)
  • Long Run - all factors are variable

The law of diminishing returns states that in the short run where at least 1 factor is fixed, successive increases in a variable factor eventually yield smaller and smaller increments in output

  • When 1 factor is fixed, increased production requires ever larger increases in the variable factor (e.g. labour - but the labour will become less and less efficient as they get in each others way - there is only a certain amount of capital that can be used).


This is the production function of a BOTTLES 4U Ltd. where labour is the variable factor and the lease payment (rent etc.) is the fixed factor


Costs in the Short Run

  • Fixed = $40 lease payment
  • Variable = Labour ($12 per unit)
  • Marginal Cost = Change in Total Cost DIVIDED by Change in Output


For profit maximisation we produce until marginal revenue = marginal cost. If the price is $0.35 the bottling company will produce 300 bottles. In a perfectly competitive market marginal revenue = price

Short Run Costs Diagram


Average total costs initially fall due to specialisation and spreading the overhead and then begin to rise due to the law of diminishing returns. MC intersects AVC and ATC at their minimum points.

Profit Maximisation

  1. Maximisation - marginal revenue = marginal cost
  2. Short Run Shut Down Condition - occurs when Price < Minimum Average Variable Costs
  3. Profitability
    • Profits = P x Q - Q x Average Total Cost (ATC)
      • Profits = Q(P - ATC)

Cases of Profit

  1. Above Normal - Marginal Revenue (Price in a perfectly competitive market) > Average Total Costs
  2. Normal - Marginal Revenue = Average Total Costs
  3. Shut Down - Marginal Revenue < Minimum Average Variable Cost

This is shown in the images below [2]


Summing Up Supply

The Firms Supply Curve [In the Short Run] is the marginal cost curve above the minimum point of the average variable cost.

Producer Surplus is the area between the price level, price axis and supply curve.

Determinants of Supply

  • Technology - Reduce costs of production
  • Input Prices
  • Expectations about future price changes
  • Prices of other products - opportunity costs (if gold price rises, silver explorers may change to gold)
  • Changes in the number of suppliers


  1. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  2. Diane Enahoro, UNSW, ASB School of Economics Lecture Notes
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