Short-run equilibrium of a perfectly competitive firm, a firm under perfect competition keeps operating in the short-run, so long as it is able to cover at least its variable costs.
Thus, a firm, which is not in a position to cover its short-run variable costs will choose to shut down its business by discontinuing its operations is the short-run. By doing so, the competitive firm minimises it losses in the short-run. Short run equilibrium of the firm is used to derive the short-run supply curve of a competitive firm.
The point at which the firm just covers its variable costs of production is called shut-down point or closing down point. With U-shaped cost curves, it is at the minimum point of the average variable cost. The corresponding price is called the shut down price or reservation price, below which the firm will not sell its product.
Image Source: policonomics.com
ADVERTISEMENTS:
Further, the corresponding output is called is shut down output. The concept of shut-down point can be used to derive the supply curve of a competitive firm in the short-run, as explained here.
In the short-run, if the market price is too low to cover even its variable costs (i.e., total revenue (TR) < total variable cost (TVC)), the firm should close down its business and should not supply any output. But, if the price (P) is equal to or more than average variable cost (AVC), the firm should produce and supply an output corresponding to which marginal cost (MC) cuts marginal revenue (MR = P) from below (equilibrium condition).
If the market price is OP0, the firm will supply an output of OQ0 and operate at equilibrium point E0, where MC is equal to MR. Similarly, when the price rises to OP1, the firm will supply an equilibrium output of OQ1. Further, when the price rises to OP1, the firm raises the supply to OQ2. Likewise, the firm supplies OQ3 output at OP3 price.
ADVERTISEMENTS:
In Fig. 10.7, OP0 is the minimum acceptable price in this short-run for the firm under consideration, below which the firm stops production. At this price, only variable costs are covered. The corresponding equilibrium point E0 is the shut-down point of the firm, where price (P) = minimum of average variable cost (AVC) and TR = TVC.
As the market price increases gradually, the firm confronts new demand curves at higher and higher levels. With positive slope of the MC curve, each higher demand curve (AR = MR) cuts the given MC curve at a point, which lies to the right of previous intersection.
This means that the quantity supplied by the firm along its MC curve increases, as price rises in the short -run. The horizontal coordinate of a point on the rising MC curve measures the quantity of product that the firm will supply at that price. Thus, the MC curve of the firm indicates the quantities of output which the firm will supply at various prices.
It is important to note that the competitive firm’s short-run supply curve is identical with only that portion of the short-run MC curve, which lies above the AVC curve. It is derived by joining the points of intersection of the MC curve with the successive individual demand curve in the short period, as the market price of the product keeps rising above its average variable cost.
ADVERTISEMENTS:
The quantity supplied by the firm is equal to zero at all prices less than those corresponding to the shut-down point. The firm’s supply curve is shown by dark segment in Fig. 10.7. However, if none of the fixed costs are sunk, the supply curve will be MC curve above the minimum AC. Increase in input price shifts the supply (MC) curve upwards as shown in Fig. 10.19.