Long term supply curve and economic profit | Microeconomics | Khan Academy

published on July 20, 2020

We've now thought a lot about the orange juice market at least at a firm specific level we in the last few videos we talked about what our average total costs and average variable costs and marginal costs are if we are running an orange juice making business now let's

Think about what happens at the market level so we're going to go back to some of what we've thought about in the past in terms of just supply and demand curves so this is the orange orange juice orange juice market and let's just

Draw some supply and demand curves right over here so this is going to be this is going to be the price per gallon price price per gallon and let's say that this right over here is one dollar this right over here is 50 cents and this is zero

Zero and let's say that this is the quantity quantity quantity in gallons per week and gallons per week and we're going to buy the entire orange juice market so this is going to be in millions of gallons per week millions

Millions of gallons per week per week and that is let's say this is one two three four five and six and let's just say and I'm going to simplify it relative to what we saw in the last video let's just say that the

Supply curve for the orange juice market and I'll be careful this time this is the near-term supply curve or the short-term supply curve looks like looks something like this that is the supply curve and this is the entire market

These are all of the orange juice producers so to get to make them produce even that first gallon it looks like they need about 20 cents for that first gallon and then each incremental gallon they need more and more money the

Marginal cost of that incremental gallon for the market as a whole is going higher and higher and higher they have to get oranges from further away and transport them further and further so this right over here is a supply curve

Or you could view it as the marginal cost marginal cost curve now let's just draw an arbitrary demand curve here so the and curve let's say it looks something like this say that's our card demand

That is our current demand curve and now what I'm going to add to this is I'm going to add the price at which firms the suppliers of the orange juice make our Neutral with returns to economic profit or when economic profit is equal

To zero so let's say right over here which happens to be our current equilibrium price this is the price so 50 cents per gallon this is the price at which economic profit is zero so I'll just write economic economic profit is

Equal to zero and I want to remind you economic profit being zero does not mean that the accounting profit is zero people could be making money at this price it just says that they're neutral whether or not they should be doing this

Business that the amount of money that they're making is roughly comparable to their opportunity costs to be doing other things so when I say economic profit is zero sometimes that's called the normal profit when economic profit

Is zero this is the price at which people are neutral between shutting down and starting up their business if you have positive economic profit that means that more people will want to go into this market and if you have negative

Economic profit that means that people are going to want to essentially use up their fixed expenses their equipment and any labor contracts they might have and then go out of business so this is where this is that point right over there now

Let's think of a couple of scenarios let's say a research paper comes out and in that research paper for whatever reason you know we don't know if it was well done research it says oranges are bad for you for whatever reason so when

The research paper comes out says oranges are bad for you what happens to demand well at any given price demand will go down at any given price demand will go down and the new demand curve might look something like this now in

The near term we have a new equilibrium price and we have a new equilibrium quantity this was the old equilibrium price that the way I set it up was just happen to be the price at which economic profit is zero and this was our old

Equilibrium quantity a little over three million gallons a week now we have a new lower equilibrium price we have a new lower equilibrium price I don't know this looks like about 40 cents per gallon and

We have a new lower equilibrium quantity now what happens at this price obviously in the near term people are willing to produce their because that's their that's where their marginal cost is so as when we saw in multiple videos that

Someone's willing to produce when the price is equal to their marginal cost or they're willing to produce a quantity up to when their marginal cost is equal to the marginal revenue or the price that they're going to get but I just said

That they need to be getting fifty cents a gallon order to make an economic profit now if they get I don't know this it looks like about 40 cents a gallon they're going to be having an economic loss so no profit no profit there and if

There's no profit there it really doesn't make sense for them to continue or at least doesn't make sense for all of them to continue in that business so what's going to happen is that over time it will make sense for them in the near

Term to produce to use up they've already put in their costs for their equipment and maybe labor contracts and whatever else but over time when prices are this low as people use up their equipment there's no incentive for them

To buy new equipment as the labor contracts expired there's no incentive for them to renew the labor contract as those things expire they're just going to shut down the business and so as they shut down the business as they shut down

The business two things will happen quantity produced in the market will go down and the price will go up we will essentially move along this curve until we get to this point that's the point once the price is at fifty cents a

Gallon again then people are neutral now they're not going to shut down their firms so we're going to get to this new equilibrium price and equilibrium quantity in the long term in the long term now let's think of another

Situation instead of a newspaper report saying that oranges are bad let's say a newspaper report comes out saying oranges are very good they make you live longer they are the best thing that you can have well then at any given price

You're going to have more demand and so you would have a demand curve that looks something like that and then you'd have a higher equilibrium quantity and a higher equilibrium price and people are going to be making system price is

Higher than the the price at which the economic profit is zero people are going to be making very positive economics profits which makes which there's a strong incentive that people are neutral between shutting down the

Business are starting up the business at that point a lot of people are strongly motivated to enter into the business so it's going to happen is more and more people are going to get more and more equipment hire more and more people and

As they do that quantity is going to go up and some end the price is going to go down and so over the long term you're going to shift back to this line once the price gets down to that then there's no reason for more people to enter there

They're kind of neutral about it so what you see happening is in the short term you would look at where the demand curve intersects with the short term supply curve but in the long term you care where it intersects with this kind of

Horizontal line which is the price at which economic profit is zero and that's why you will hear this is kind of a more precise way of thinking about it then we've done in the previous videos this horizontal line right over here you

Could view this as the long run the long run long run supply curve long run supply curve and that says look pretty much whatever we will always produce over the long run we will always produce whatever supply is kind of necessary

Given that people are neutral when it comes to economic profit you go down here yes people will try to use up their fixed costs but once they're used up their fixed costs no incentive for them to stay in business then some of them go

Out of business price goes up quantity goes down you get back to the long-run supply curve and where that intersects with the demand curve or if the opposite happens a lot of economic profit a lot of entrance

Into the market price goes down supply goes up you get back to the long run supply curve or I guess you could say you go back to where the new demand curve is intersecting the long-run supply curve

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