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Voiceover: We've now thought a lot about
the orange juice market,
at least at a firm-specific level
within 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.
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.
This is the orange juice,
orange juice market,
and let's just draw some supply and demand curves
right over here.
This is going to be,
this is going to be the price per gallon,
price per gallon,
and let's say that this right over here is $1.
This right over here is 50 cents,
and this is 0,
and let's say that this is the quantity,
quantity,
quantity in gallons per week,
and gallons per week.
We're going to talk about the entire
orange juice market,
so this is going to be in millions of gallons per week.
Millions of gallons per week,
per week.
That is, let's say this is 1, 2, 3, 4, 5, and 6.
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.
This is the entire market.
These are all of the orange juice producers.
So to get them to 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
and for the market as a whole
is going higher and higher and higher.
They have to get oranges from futher away
and transport them further and further.
This right over here is the supply curve,
or you could view it as the marginal cost,
marginal cost curve.
Now let's just draw an arbitrary demand curve here.
The demand curve,
let's say it looks something like this.
Let's say that's our current demand,
that is our current demand curve,
and then 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
are neutral with returns to economic profit,
or when economic profit is equal to 0.
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 0.
so I'll just write economic profit is equal to 0.
I want to remind you,
economic profit being 0
does not mean that the accounting profit is 0.
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 cost
to be doing other things.
When I say economic profit is 0,
sometimes that's called the normal profit,
when economic profit is 0.
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.
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,
we don't know if it was well-done research.
It says oranges are bad for you,
for whatever reason.
When the research paper comes out
and 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 quanitity.
This was the old equilibrium price,
the way I set that up,
it just happened to be the price
at which economic profit is 0,
and this was our old equilibrium quantity,
a little over 3 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 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 there
because that's where their marginal cost is,
so, as 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 50 cents a gallon
in order to make an economic profit.
Now if they get, I don't know,
this looks like about 40 cents a gallon,
they're going to be having an economic loss.
So no profit.
No profit there.
If there's no profit there,
it really doesn't make sense for them to continue,
or at least it doesn't make sense for all of them
to continue in that business.
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 cost
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 expire,
there's no incentive for them to renew
the labor contract.
As those things expire,
they're just going to shut down the business.
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 50 cents a gallon again,
then people are neutral now.
They're not going to shut down their firms.
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'd have a demand curve
that looks something like that.
Then, you'd have a higher equilibrium quantity,
and a higher equilibrium price.
And, people are going to be making,
since the price is higher,
than the price at which the economic profit is 0,
people are going to be making
very positive economic profits,
which means that there's a strong incentive,
that people are neutral between
shutting down the business
or starting up the business.
At that point,
a lot of people are strongly motivated
to enter into the business.
What'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 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.
They're kind of neutral about it.
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 0.
That's why you will hear,
and this is kind of a more precise way
of thinking about it than 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.
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 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,
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.
I guess you could say,
you could go back to where the new demand curve
is intersecting the long run supply curve.
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Long Term Supply Curve and Economic Profit

1014 Folder Collection
Bravo001 published on October 4, 2014
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