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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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