DETERMINATION OF SHORT-RUN PRICE
In a preceding chapter, we explained that in the short-run a firm is in equilibrium at the output at which price equals marginal cost. It was also pointed out that, during the short-run, fixed costs arc disregarded in making a decision whether to produce or not. It is the average variable cost rather than average total cost which is of determining importance to decide whether to produce or not. If the price falls below the minimum average variable cost, then even in the short-run firms will shut down to minimize losses. Thus, the minimum average variable cost sets a minimum limit to the price in the short-run since at a price below it no amount of output will be produced. We also pointed out that short-run supply curve of the industry is the lateral summation of the short-run marginal cost curves of the firms. The suppl y curve of the industry lies above the minimum average variable costs. The short-run supply curve of the industry slopes upward from left to right since Ole short-run marginal cost curve of the firms slopes upwards too. The determination of the short-run price can be explained (b) is the demand curve facing the industry. This demand curve as usual slopes downwards from left to right. MPS is the market period supply curve (its vertical shape shows that it is fixed) and SRS the short-run supply curve of the industry, If there an increase in demand from 00 to D’ I),. the market price will rise sharply from OJ> to OK at which level the new demand curve D’O’ intersects the market period supply curve MPS, supply of output remaining unchanged.
But, under the stimulus of this increased demand. Ole firms will increase their production in the short period, by making intensive use of the fixed capital equipment and increasing the amount’ of variable factors. It should be borne in mind that, in the short period. no change in the fixed capital equipment can be made, nor can new firms enter the industry. The supply of the will increase as a result of the e. pension of output by the firms: using more variable factors. in response to increase in demand. Hence, in the short-run price will fall to OR at which new demand curve D’ Cursor Cats Ole short-run supply curve SRS.
Thus. OR is the short-run normal price which is higher than the original market price 01′ but not as high as the second market price of OK. The quantity applied has also increased from OM to OM ‘. I knee. III the short-run, a larger amount of the quantity is sold and the price is quite as high as in the market period. Given the demand curve D”D”, the short-run normal price OR is established in the market. Individual firms will take this price as given and constant and will adjust their output level so that the price equals marginal cost. it is clear that. at price OR, the firm is making super-normal profits since since price OR is greater than the Now. if there is a decrease in demand from DO to the market price will fall sharply from to OL at which level demand curve intersects the MI’S curve, the supply of the output remaining the same. But, ill the short-run, firms will contract output by diminishing the variable factors and.as a result. the quantity supplied will decrease. 111e short-run normal price will be OT at which short-run supply curve SRS intersects the new demand curve Thus. short-run price OT will he higher than the new market price OL but will be lower than the original market price OJ Again, OT, the new short-run price, will be taken as given and constant by the firms
and they will adjust their output at which OT equals marginal cost. It will be seen from that at price OT firms would be incurring losses. Price cannot fall below the point Dink at prices below 0 firms would not produce any amount of thc commodity and the quantity supplied will be zero. average cost at equiIibnum