10.A. from Firm Supply to Market Supply

10.a. From Firm Supply to Market Supply

The supply curve of a single competitive firm is identical to the firm’s marginal cost curve MC, except that the firm will shut down if the price drops below the average cost of production. So in figure 10.a.1, the firm’s supply curve is given by the bold portion of marginal cost MC. At a price of PA the firm will produce the quantity QA and will earn zero profit. Below the price PAthe firm will produce nothing, and above PAthe firm will produce the quantity shown by the marginal cost curve MC.

In figure 10.a.2 we see how to add the supply curves of two firms to get the industry supply curve. Two firms, A and B, have supply curves SAand SB. The bold curve S is the combined supply curve of the two firms, and is usually called the industry supply curve. The industry supply curve is the horizontal sum of SAand SB. This means, for example, that when the price is $17, firm A will produce 21 units and firm B will produce 33 units, so that the industry produces 21+37=54 units. At a price below $12, firm A shuts down, so industry supply is identical to SB. Once the price reaches $12, firm A enters the market, producing 10 units. Industry supply suddenly increases by 10 units (from 27 to 37), which puts a horizontal step in the industry supply curve. Above the price of $12, industry supply is the simple horizontal sum of SAand SB. Note that if we were to add more firms to the industry, we would simply add more firm supply curves (SC, SD, etc.), and a portion of the industry supply curve would shift to the right each time a new firm entered the market.

Horizontal summation for the case of three firms, A, B, and C, is shown in figure 10.a.3. The third firm C enters the market at a price of $17, producing 10 units at first. As a result, the quantity supplied by the industry suddenly rises by 10 units (from 54 to 64) when the price reaches $17. Above $17, the industry supply curve is the sum of the supplies of all three firms, A, B, and C. When an industry consists of many firms, the industry supply curve will have many small steps in it, each step representing the shut-down price of some firm. Since these steps will look very small relative to the whole industry supply curve, we usually draw the industry supply curve as a smooth, upward-sloping curve.