Economics: Shifts in Short-Run Market Supply Curve

This lesson has not been reviewed.

Please purchase the lesson to review.

There was a lot to cover in this diagram and I find that when I give this explanation, students always have questions. I'm going to try anticipate some of your questions and answer them in this segment. The first question that students often ask is what causes the short run supply curve to shift? What causes this green curve to change its position? What leads to a larger quantity of output at any given price?
Now, over on the board I have redrawn the short run supply curve by itself and I am going to talk about the things that would cause the short run supply to change its position. In particular, let's talk about what would cause it to shift outwards. To answer this question, start with recalling what the short run supply curve is. The short run supply curve is the sum of all of the firm's individual short run marginal cost curves above the shut down point. If you take all of the firms that are in the market at a given time and you add up their short run supply curves, that is, the amount of output they will produce at a particular price, you get the short run supply curve for the market. It's the sum of the individual firm's short run supply curves above the shut down point. Now, what would cause those curves to shift outwards? Well, there're two things that would cause this shift to happen. First, would be a change within the firms that are producing currently. The second would be adding more firms. Either of those would cause the curve to shift. Let's start with a change in the existing firms.
Suppose the existing firms suddenly had a shift from a few trucks in the short run to a lot of trucks in the long run. If the existing firms acquire more capital, then the marginal product of labor is going to change. If you have five workers working with a single truck, the marginal product of labor is going to be very low, but if you have five workers working with three trucks, then the marginal product of labor is going to be high. Remember, the marginal cost of production is the reciprocal of the marginal product of labor. So, when the firm gets more capital, when the firm moves from the short run to the long run, and is able to acquire more trucks, then the marginal product of labor increases and as the marginal product of labor increases, the marginal cost of production decreases. So, we can show it this way: we're moving from one set of short run marginal cost curves with only a few trucks to another set of short run marginal cost curves that have more trucks, and in that case, the marginal cost of production is going to be lower. It's like we're moving from this particular set of marginal cost curves to this other set of marginal cost curves that are further up along the long run average cost curve that have a lower marginal cost because the marginal product of labor is higher. Now, that's a round about way of saying that one thing that can shift out the short run supply curve is if the existing firms get more capital. As we move from the short run to the long run, the short run supply curve will move outwards because the existing firm may acquire more capital and when they acquire more capital, labor becomes more productive and the marginal cost falls for the individual firms. All right, that's reason number one. Short run supply curve shifts outward if the existing firms get more capital.
The second reason that the short run supply curve will shift outward is adding more firms. In the long run, when there is free entry, the existence of profit in this market will attract new firms into the industry. When new firms are attracted into the industry, those new firms add their short run supply curves to the market, and that cause the market short run supply curve to shift outwards. It shifts outwards because we are adding new firms. It's that simple. So, what causes the green curve to shift around? There are two things. The first is a change in the fixed inputs of our given firms, our existing firms. The second is adding new firms. You can consider the process in reverse. If firms leave the market, the short run supply curves shifts inward and if firms cut back on their capital, that is, in the long run when they're able to lay off some of their trucks or sell them or return them to the people from whom they've rented them, then the capital stock shrinks, and when the capital stock shrinks, the marginal productivity of labor falls and the marginal cost rises again. So the same two ideas are at work whether the curve is shifting outward or inward. A change in the capital stock changes marginal product and that changes marginal cost, that's reason number one, and a change in the number of firms causes the short run supply curve to shift, that's reason number two.
Another question that students ask is when do you move along the cost curves and when do the cost curves shift? Let's see if I can answer that one. Over here, we have the long run and the short run cost curves, and I've reproduced them over on the board so that we can talk about them. First, anything that changes the price of the firm's product is going to cause a movement along the cost curves. Remember, you can never shift the curve by changing what's on one of its axis. You can only shift the curve by changing something that isn't in the picture. You can only shift a curve by changing something that you're holding constant when you draw the picture. So, if the price of the firm's product changes, you will move along the curve. In the short run, the firm will move along the short run marginal cost curve, and in the long run, the firm will move along the long run marginal cost curve as the firm expands its output. However, if you change one of the things that's held constant when you draw this picture, then you'll shift the whole set of curves. For instance, let's suppose that the price of the firm's input increase; let's suppose that the price of labor and capital increases. In that case, what will happen to the cost curve is this: the whole set of cost curves will shift upwards representing an increase in the cost of producing any given quantity of output. If the price of the input falls, then the cost curves will all shift downwards representing a reduction in the cost of producing any quantity of output. The next thing that could shift the cost curves would be a change in technology. If the firm's technology improves, that is, if it can make more output with a given amount of input than before, then the cost curves will shift downwards because now the firm can produce its target level of output with less input, and therefore, at lower cost. So, the thing that will shift the cost curves will be a change in the price of the firm's input or a change in the firm's technology. One more thing to point out, I told you a moment ago that when the firm moves into the long run and changes its quantity of capital, there is a shift in the short run supply curve. That shift occurs not because the short run marginal cost curve actually shifts, but because the firm moves from one short run marginal cost curve to another short run marginal cost curve. Remember, anytime you change the amount of the fixed input, you have to change the short run marginal cost. The short run marginal cost is based on labor productivity, which depends on the amount of tools or capital that the workers have to work with. Anytime you pick a point on our blue long run average cost curve, any time you pick a point, you can hold the capital constant and draw a new green curve that's tangent at that point. If firms acquire more capital in the long run, they're going to be moving from this set of short run cost curves to another set of short run cost curves at a different point on the long run average cost curve. So, its not that the green curve actually shifts, for a single firm, it's that you move from one set of short run cost curves to another set of short run cost curves.
Perfect Competition
Market Supply
Examining Shifts in the Short Run Market Supply Curve Page [2 of 2]