0:00:00.000,0:00:03.000 ♪ [music] ♪ 0:00:09.470,0:00:12.170 - [Alex Tabarrok] Now that [br]we understand a firm's cos tcurves, 0:00:12.170,0:00:13.870 and its entry and exit decisions, 0:00:13.870,0:00:17.255 we're able to show how [br]supply curves are actually 0:00:17.255,0:00:20.744 derived from these more [br]fundamental considerations. 0:00:21.184,0:00:22.618 Let's take a closer look. 0:00:27.900,0:00:31.894 The supply curve is built upon [br]firm entry and exit decisions 0:00:31.894,0:00:35.440 and the effect of these decisions [br]on industry costs. 0:00:35.440,0:00:39.510 And the key question is this, [br]as industry output increases, 0:00:39.510,0:00:41.940 what happens to costs? 0:00:41.940,0:00:45.550 There are three possibilities.[br]First, an increase in cost industry. 0:00:45.550,0:00:49.460 That is industry costs increase [br]with greater output. 0:00:49.460,0:00:51.850 Second, constant cost industry. 0:00:51.850,0:00:53.100 Industry costs are flat, [br] 0:00:53.100,0:00:56.510 they don't change [br]with greater or lesser output. 0:00:56.510,0:00:59.090 And finally a decreasing [br]cost industry, 0:00:59.090,0:01:01.740 industry cost falls [br]with greater output. 0:01:01.740,0:01:04.400 As we'll see, the first and second [br]are quite common, 0:01:04.400,0:01:06.260 the third is quite uncommon, 0:01:06.260,0:01:09.300 but is nevertheless important [br]and interesting 0:01:09.300,0:01:11.436 in order to understand [br]economic geography, 0:01:11.436,0:01:13.230 which we'll come to a bit later. 0:01:13.230,0:01:14.370 Let's show how the industry [br] 0:01:14.370,0:01:17.590 supply curve is derived [br]from the entry and exit 0:01:17.590,0:01:20.390 and cost curves [br]of individual firms. 0:01:20.390,0:01:23.400 We can do this for an increase [br]in cost industry very easily 0:01:23.400,0:01:25.390 with just a two firm example. 0:01:25.390,0:01:28.330 Suppose that Firm one[br]is a producer of oil, 0:01:28.330,0:01:30.310 where its oil is very [br]close to the surface, 0:01:30.310,0:01:33.250 so it has a quite [br]low average cost curve. 0:01:33.250,0:01:35.820 It's pretty cheap [br]for this firm to produce oil. 0:01:35.820,0:01:40.070 On the other hand, Firm two has [br]a much higher average cost curve 0:01:40.070,0:01:43.320 because for Firm two is located [br]in a part of the world 0:01:43.320,0:01:47.211 where it has to drill much deeper [br]in order to get the oil. 0:01:48.090,0:01:49.930 Now, given these figures 0:01:49.930,0:01:53.330 what's the industry [br]supply curve of oil 0:01:53.330,0:01:57.240 if the price of oil is below $17? 0:01:58.680,0:02:01.700 Well, if the price of oil [br]is below $17, 0:02:01.700,0:02:04.840 neither of these firms [br]can make a profit. 0:02:04.840,0:02:07.099 That's below the minimum point [br]of the average cost curve 0:02:07.099,0:02:08.939 for both of these firms. 0:02:08.939,0:02:09.980 So neither of these firms 0:02:09.980,0:02:11.920 is going to want [br]to be in the industry. 0:02:11.920,0:02:14.860 So if the price of oil [br]is below $17, 0:02:14.860,0:02:19.560 the industry supply is just [br]going to be zero, right here, zero. 0:02:20.300,0:02:23.490 Now what happens at $17? 0:02:23.490,0:02:27.530 Well at $17, Firm one just breaks even. 0:02:27.530,0:02:30.890 So we'll say Firm one [br]will just enter the industry. 0:02:30.890,0:02:35.190 So at $17, the industry output[br]is the same as 0:02:35.190,0:02:38.824 the output of Firm one,[br]namely four units. 0:02:39.130,0:02:43.160 Notice that at $17, Firm two [br]doesn't enter the industry 0:02:43.160,0:02:46.420 because the price is still too low. 0:02:46.420,0:02:48.520 Firm two is not going [br]to make a profit, 0:02:48.520,0:02:50.950 will take a loss at that price. 0:02:50.950,0:02:54.430 Indeed as the price of oil [br]increases, 0:02:54.430,0:02:59.590 the output from Firm two [br]will increase as it moves along 0:02:59.590,0:03:01.610 its marginal cost curve. 0:03:01.610,0:03:05.460 That will continue to happen[br]so industry output will increase 0:03:05.460,0:03:07.423 along with the output of Firm one 0:03:07.423,0:03:10.613 until we reach a price of $29. 0:03:10.613,0:03:13.000 At the price of $29, 0:03:13.000,0:03:16.530 Firm two just breaks even [br]and it enters the industry. 0:03:16.530,0:03:22.068 So at $29, total industry output [br]is six units from Firm one 0:03:22.068,0:03:24.710 and five units from Firm two 0:03:24.710,0:03:28.640 for a total of 11 units [br]from the industry. 0:03:29.520,0:03:34.948 As the price goes above $29 [br]both Firm one and Firm two 0:03:34.948,0:03:37.398 expand along [br]their marginal cost curves 0:03:37.398,0:03:39.808 so the industry output is then 0:03:39.808,0:03:43.745 the sum of the output [br]from both firms. 0:03:43.745,0:03:49.785 So what we see here [br]is that the industry supply curve 0:03:49.785,0:03:51.575 is upward sloping [br] 0:03:51.575,0:03:56.825 because the cost curves [br]of these firms are different. 0:03:56.825,0:04:01.387 Because in order to attract [br]more firms into this industry, 0:04:01.387,0:04:06.110 the only way we can do that [br]is by attracting higher cost firms. 0:04:06.110,0:04:10.720 So the industry supply curve [br]is upward sloping. 0:04:11.930,0:04:15.020 Any industry where [br]it's difficult to exactly duplicate 0:04:15.020,0:04:18.780 the productive inputs is going [br]to be an increase in cost industry. 0:04:18.780,0:04:22.490 I've already mentioned oil, [br]but copper, gold, silver, 0:04:22.490,0:04:24.940 all the mining industries[br]are very similar. 0:04:24.940,0:04:27.590 We can't just duplicate [br]another gold mine. 0:04:27.590,0:04:29.710 If we want another gold mine [br]we're going to have to dig deeper, 0:04:29.710,0:04:30.950 we're going to have [br]to look elsewhere, 0:04:30.950,0:04:34.420 it's going to be more expensive [br]to produce it than it is now. 0:04:34.420,0:04:36.970 Coffee is another example,[br]because there's really only 0:04:36.970,0:04:38.990 a limited number [br]of places in the world 0:04:38.990,0:04:41.310 where we could produce [br]great coffee. 0:04:41.310,0:04:44.910 If we want coffee from other places[br]than Brazil or Guatemala, 0:04:44.910,0:04:46.570 it's going to be lower quality. 0:04:46.570,0:04:49.790 We're going to have to go[br]down further on the mountain. 0:04:49.790,0:04:52.360 It's going to require more inputs. 0:04:52.360,0:04:53.840 Nuclear engineers -- 0:04:53.840,0:04:56.660 very hard to expand [br]the supply of nuclear engineers. 0:04:56.660,0:05:00.240 There's a limited number of people [br]who can be a nuclear engineer. 0:05:00.240,0:05:03.134 If we want more nuclear engineers,[br]we're really going to have 0:05:03.134,0:05:05.650 to pull them from other industries [br] 0:05:05.650,0:05:07.920 where they have [br]very high opportunity cost. 0:05:07.920,0:05:11.480 So it's hard to expand the supply [br]of nuclear engineers 0:05:11.480,0:05:15.530 without pushing up the wages [br]of nuclear engineers. 0:05:15.530,0:05:17.532 That's an increasing cost industry.[br] 0:05:18.200,0:05:23.600 Moreover, any industry that buys [br]a large fraction of the output 0:05:23.600,0:05:25.660 of an increasing cost industry [br] 0:05:25.660,0:05:28.650 will also be an increasing [br]cost industry. 0:05:28.650,0:05:32.750 So pretty obviously gasoline [br]is an increasing cost industry 0:05:32.750,0:05:37.040 because if we want more gasoline [br]that requires more oil, 0:05:37.040,0:05:40.370 and oil is an increasing [br]cost industry. 0:05:40.370,0:05:43.630 Electricity will primarily be [br]an increasing cost industry 0:05:43.630,0:05:47.220 to the extent that we generate [br]our electricity from coal. 0:05:47.220,0:05:50.570 So if we want a lot more electricity [br]we're going to require more coal 0:05:50.570,0:05:53.015 and that's going to push [br]the price of coal up, 0:05:53.015,0:05:56.635 which is going to push the cost [br]of producing electricity up. 0:05:57.555,0:06:01.160 So what we just showed is that [br]for an increasing cost industry, 0:06:01.160,0:06:04.900 you can derive a upward sloped [br]supply curve. 0:06:04.900,0:06:06.920 We're now going to do a constant [br]cost industry 0:06:06.920,0:06:09.890 for which we'll show you actually [br]get a flat supply curve, 0:06:09.890,0:06:12.259 and then a decreasing cost industry, 0:06:12.259,0:06:13.629 which as you might expect, [br] 0:06:13.629,0:06:16.600 will give you now a [br]downward-sloped supply curve. 0:06:16.600,0:06:19.100 We'll do these in separate lectures.[br]Thanks. 0:06:20.100,0:06:21.550 - [Announcer] If you want to test yourself,[br] 0:06:21.550,0:06:23.010 click, "Practice Questions," 0:06:24.000,0:06:27.431 or if you're ready to move on,[br]just click, "Next Video." 0:06:27.431,0:06:30.400 ♪ [music] ♪