How to Find a Market Supply From the Marginal Cost

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Market supply may be obtained from marginal cost in the case of perfect competition.
Market supply may be obtained from marginal cost in the case of perfect competition. (Image: PhotoObjects.net/PhotoObjects.net/Getty Images)

Short-run market supply, along with market demand, is one of the core concepts in microeconomics. It is used to understand the production behaviors of a firm which, in turn, will have an impact on market prices. In the case of a perfectly competitive market, the marginal cost curve may be derived from both marginal cost and average variable cost. It should be noted that a market in perfect competition is largely theoretical, and thus deriving the supply curve in this manner can only be done on paper.

Derive the marginal cost of the firm. The marginal cost of a firm is the change of cost that arises from a change in output. Put more simply, given a certain level of production, the marginal cost is the additional cost of producing one extra unit of output. It may be obtained by using calculus. If you have a firm's total cost curve, which is the total cost of a given level of output, the marginal cost curve is simply the derivative of that curve. When graphed with the quantity of the x-axis and the cost on the y-axis, the marginal cost curve takes a small dip before bouncing back and increasing forever.

Determine the total variable cost and the average variable cost of the firm. A firm's total costs may be divided into two types. Total fixed costs are those that do not change with quantity and may include rent on a factory, for example. Total variable costs are those that do vary with the quantity of goods produced. The greater the quantity, the greater the total variable costs. This is because it costs more to produce more. The average variable cost is the total variable cost curve divided by the quantity. When graphed, with the quantity on the x-axis and the cost on the y-axis, the average variable cost curve gradually falls and then gradually increases. This is due to the laws of increasing and diminishing marginal returns.

Derive the short-run supply curve. Both the marginal cost curve and the average variable cost curve are U-shaped. Both curves intersect with each other at some point. This point is where the U-shaped average variable cost curve is at its lowest point. The part of the marginal cost curve above the average variable cost curve is the short-run supply curve. This is especially true for firms that exhibit perfect competition, that is, a market with a large amount of small firms producing identical products.

Tips & Warnings

  • In perfect competition, any price changes felt in the market are responded to by raising the marginal cost curve which, in turn, produces the short-run supply curve. This does not occur in other types of market structure. Monopolies, oligopolies and monopolistically competitive firms have a level of discretion, when setting the price of their goods, as there is less competition in the market. Therefore, prices of goods are set according to market demand and are not influenced by the cost in producing them. The marginal cost curve in this case is comprised of all of the marginal cost curves for all firms in the market.

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