5 Steps to a 5 AP Microeconomics, 2014-2015 Edition

Market Structures, Perfect Competition, Monopoly, and Things Between ‹ 123

Short-Run Supply

As you can see in Figure 9.5, when the price fluctuates between PH and PD, the firm finds

a new profit-maximizing quantity where P =MR =MC. If price increases, quantity sup-

plied increases. If price decreases, quantity supplied decreases. This is a restatement of the

law of supply. This movement upward and downward along the marginal cost curve implies

that MC serves as the supply curve for the perfectly competitive firm. The only exception

is when the price falls below the shutdown point (minimum of AVC) and the firm quickly

decides to produce nothing. The market supply curve is simply the summation of all firms’

MC curves.

• The MC curve above the shutdown point serves as the supply curve for each perfectly
  competitive firm.


• The market supply curve is therefore the sum of all of the MC curves: S =SMC.

Long-Run Adjustment

The short run is a period of time too brief for firms to change the size of their plants.

This means that it is also too short for existing firms to exit the industry in bad times and

too short for new entrepreneurs to enter the industry in good times. The “free entry and

exit” characteristic of perfect competition assures us that in the long run, we can expect

to see firms either exiting or entering, depending upon whether profits or losses are being

made in the short run. We’ll first examine the case where short-run positive profits are

made in the carrot industry. Then we’ll look at the situation where short-run losses are

incurred.

• In virtually all of the past AP Microeconomics exams, free-response questions have
  appeared that test the students’ knowledge of perfect competition and the difference
  between the short- and long-run equilibria.

Short-Run Positive Profits

Figure 9.6 illustrates the perfectly competitive carrot industry where the market price is

above average total cost. Firms are earning positive short-run profits, as illustrated by the

shaded rectangle.

So what next? Well, many entrepreneurs on the outside of this market are attracted

by the positive short-run profits being made by carrot producers. Given sufficient time

(i.e., the long run), these new firms enter the market. With more carrot producers, the

market supply curve shifts outward, driving down the price. As the price falls, the profit

rectangle gets smaller and smaller until it actually disappears. At the point where

Output

Price $

AVC

MC

ATC

PL

PD

PM

PH

q 1 qdqmqh

Shutdown

point

Figure 9.5

KEY IDEA

TIP