Question

Explain how a segment of the SMC curve of a firm is its supply curve in the short-run.

Answer 1

The short-run supply curve of a perfectly competitive firm shows how much output it will supply at different prices. A firm reaches equilibrium where its Marginal Cost (MC) = Marginal Revenue (MR). Since MR = Price in perfect competition, the firm decides its output based on the MC curve.

At price P₀, the firm just covers its Average Variable Cost (AVC). The point where AR = AVC is the shutdown point, below which the firm stops production. So, the firm’s minimum supply is OQ₀.

At price P₁, AR = SAC, and the firm just covers both variable and fixed costs. This is called the break-even point, where the firm earns normal profit.

At higher prices like P₂ and P₃, the firm earns supernormal profits because AR > SAC, and it supplies more output (OQ₂, OQ₃).

By connecting all the equilibrium points (E₀, E₁, E₂, E₃), we get the firm’s short-run supply curve, which is the upward-sloping portion of the MC curve above the AVC.