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Entry, Exit, and Supply Curves: Increasing Costs

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    ♪ [music] ♪
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    - [Alex Tabarrok] Now that
    we understand a firm's cos tcurves,
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    and its entry and exit decisions,
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    we're able to show how
    supply curves are actually
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    derived from these more
    fundamental considerations.
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    Let's take a closer look.
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    The supply curve is built upon
    firm entry and exit decisions
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    and the effect of these decisions
    on industry costs.
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    And the key question is this,
    as industry output increases,
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    what happens to costs?
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    There are three possibilities.
    First, an increase in cost industry.
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    That is industry costs increase
    with greater output.
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    Second, constant cost industry.
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    Industry costs are flat,
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    they don't change
    with greater or lesser output.
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    And finally a decreasing
    cost industry,
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    industry cost falls
    with greater output.
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    As we'll see, the first and second
    are quite common,
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    the third is quite uncommon,
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    but is nevertheless important
    and interesting
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    in order to understand
    economic geography,
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    which we'll come to a bit later.
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    Let's show how the industry
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    supply curve is derived
    from the entry and exit
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    and cost curves
    of individual firms.
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    We can do this for an increase
    in cost industry very easily
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    with just a two firm example.
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    Suppose that Firm one
    is a producer of oil,
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    where its oil is very
    close to the surface,
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    so it has a quite
    low average cost curve.
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    It's pretty cheap
    for this firm to produce oil.
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    On the other hand, Firm two has
    a much higher average cost curve
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    because for Firm two is located
    in a part of the world
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    where it has to drill much deeper
    in order to get the oil.
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    Now, given these figures
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    what's the industry
    supply curve of oil
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    if the price of oil is below $17?
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    Well, if the price of oil
    is below $17,
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    neither of these firms
    can make a profit.
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    That's below the minimum point
    of the average cost curve
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    for both of these firms.
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    So neither of these firms
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    is going to want
    to be in the industry.
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    So if the price of oil
    is below $17,
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    the industry supply is just
    going to be zero, right here, zero.
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    Now what happens at $17?
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    Well at $17, Firm one just breaks even.
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    So we'll say Firm one
    will just enter the industry.
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    So at $17, the industry output
    is the same as
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    the output of Firm one,
    namely four units.
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    Notice that at $17, Firm two
    doesn't enter the industry
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    because the price is still too low.
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    Firm two is not going
    to make a profit,
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    will take a loss at that price.
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    Indeed as the price of oil
    increases,
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    the output from Firm two
    will increase as it moves along
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    its marginal cost curve.
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    That will continue to happen
    so industry output will increase
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    along with the output of Firm one
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    until we reach a price of $29.
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    At the price of $29,
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    Firm two just breaks even
    and it enters the industry.
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    So at $29, total industry output
    is six units from Firm one
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    and five units from Firm two
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    for a total of 11 units
    from the industry.
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    As the price goes above $29
    both Firm one and Firm two
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    expand along
    their marginal cost curves
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    so the industry output is then
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    the sum of the output
    from both firms.
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    So what we see here
    is that the industry supply curve
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    is upward sloping
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    because the cost curves
    of these firms are different.
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    Because in order to attract
    more firms into this industry,
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    the only way we can do that
    is by attracting higher cost firms.
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    So the industry supply curve
    is upward sloping.
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    Any industry where
    it's difficult to exactly duplicate
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    the productive inputs is going
    to be an increase in cost industry.
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    I've already mentioned oil,
    but copper, gold, silver,
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    all the mining industries
    are very similar.
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    We can't just duplicate
    another gold mine.
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    If we want another gold mine
    we're going to have to dig deeper,
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    we're going to have
    to look elsewhere,
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    it's going to be more expensive
    to produce it than it is now.
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    Coffee is another example,
    because there's really only
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    a limited number
    of places in the world
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    where we could produce
    great coffee.
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    If we want coffee from other places
    than Brazil or Guatemala,
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    it's going to be lower quality.
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    We're going to have to go
    down further on the mountain.
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    It's going to require more inputs.
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    Nuclear engineers --
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    very hard to expand
    the supply of nuclear engineers.
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    There's a limited number of people
    who can be a nuclear engineer.
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    If we want more nuclear engineers,
    we're really going to have
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    to pull them from other industries
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    where they have
    very high opportunity cost.
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    So it's hard to expand the supply
    of nuclear engineers
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    without pushing up the wages
    of nuclear engineers.
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    That's an increasing cost industry.
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    Moreover, any industry that buys
    a large fraction of the output
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    of an increasing cost industry
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    will also be an increasing
    cost industry.
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    So pretty obviously gasoline
    is an increasing cost industry
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    because if we want more gasoline
    that requires more oil,
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    and oil is an increasing
    cost industry.
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    Electricity will primarily be
    an increasing cost industry
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    to the extent that we generate
    our electricity from coal.
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    So if we want a lot more electricity
    we're going to require more coal
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    and that's going to push
    the price of coal up,
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    which is going to push the cost
    of producing electricity up.
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    So what we just showed is that
    for an increasing cost industry,
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    you can derive a upward sloped
    supply curve.
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    We're now going to do a constant
    cost industry
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    for which we'll show you actually
    get a flat supply curve,
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    and then a decreasing cost industry,
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    which as you might expect,
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    will give you now a
    downward-sloped supply curve.
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    We'll do these in separate lectures.
    Thanks.
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    - [Announcer] If you want to test yourself,
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    click, "Practice Questions,"
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    or if you're ready to move on,
    just click, "Next Video."
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    ♪ [music] ♪
Title:
Entry, Exit, and Supply Curves: Increasing Costs
Description:

We understand cost curves and entry and entry/exit decisions. Now we are going to explore how each firm’s decisions influence the supply curve. Here’s the key question: As industry output increases, what happens to costs? We look at three options: an increasing cost industry, a constant cost industry, and a decreasing cost industry.
First up, we look at oil as an example of an increasing cost industry. One oil company drills for oil that is close to the surface, and the second company drills for oil deep underground. Other examples of increasing cost industries include copper, gold, and silver, coffee, and even the profession of nuclear engineers.
Microeconomics Course: http://mruniversity.com/courses/principles-economics-microeconomics

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Next video: http://mruniversity.com/courses/principles-economics-microeconomics/supply-curve-constant-cost-industry

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Video Language:
English
Team:
Marginal Revolution University
Project:
Micro
Duration:
06:33

English subtitles

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