Economics (NCERT) Notes

4.6 Long-Run Supply Curve of a Firm

Long run supply curve
•We split the derivation into two parts.
     1. We determine the firm’s profit-maximising output level when the market price is greater than or equal to the minimum (long run) AC.
     2. We determine the firm’s profit maximizing output level when the market price is less than the minimum (long run) AC.
 
Case 1: Price greater than or equal to the minimum LRAC
•Suppose the market price is p1, which exceeds the minimum LRAC.
•Upon equating p1 with LRMC on the rising part of the LRMC curve, we obtain output level q1.
•LRAC at q1 does not exceed the market price, p1.
•Thus, all three conditions are satisfied at q1.
•Hence, when the market price is p1, the firm’s supplies in the long run become an output equal to q1.
 
Case 2: Price less than the minimum LRAC
•Suppose the market price is p2, which is less than the minimum LRAC.
•According to condition 3, if a profit-maximising firm produces a positive output in the long run, the market price, p2, must be greater than or equal to the LRAC at that output level.
•It is evident from Figure, that for all positive output levels, LRAC strictly exceeds p2.
•Hence, when the market price is p2, the firm produces zero output.
 
Conclusion
•Combining cases 1 and 2, we reach an important conclusion.
•A firm’s long run supply curve is the rising part of the LRMC curve from and above the minimum LRAC together with zero output for all prices less than the minimum LRAC.
•In Figure, the bold line represents the long run supply curve of the firm.
 
The Shut Down Point
•In the short run the firm continues to produce as long as the price remains greater than or equal to the minimum of AVC.
•Therefore, along the supply curve as we move down, the last price-output combination at which the firm produces positive output is the point of minimum AVC where the SMC curve cuts the AVC curve.
•Below this, there will be no production.
•This point is called the short run shut down point of the firm.
•In the long run, the shut down point is the minimum of LRAC curve.
 
The Normal Profit
•The minimum level of profit that is needed to keep a firm in the existing business is defined as normal profit.
•Normal profits are therefore a part of the firm’s total costs.
•It may be useful to think of them as an opportunity cost for entrepreneurship.
•Profit that a firm earns over and above the normal profit is called the super-normal profit.
•In the long run, a firm does not produce if it earns anything less than the normal profit.
•In the short run, however, it may produce even if the profit is less than this level.
•The point on the supply curve at which a firm earns only normal profit is called the break-even point of the firm.



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