Chapter Introduction


Perfect Competition and the Supply Curve



Whether Christmas trees or smartphones, how a good is produced determines its cost of production.

What You Will Learn in This Chapter

  • What a perfectly competitive market is and the characteristics of a perfectly competitive industry

  • How a price-taking producer determines its profit-maximizing quantity of output

  • How to assess whether or not a producer is profitable and why an unprofitable producer may continue to operate in the short run

  • Why industries behave differently in the short run and the long run

  • What determines the industry supply curve in both the short run and the long run

image | interactive activity

ONE SURE SIGN THAT IT’S THE holiday season is the sudden appearance of Christmas tree sellers, who set up shop in vacant lots, parking lots, and garden centers all across the country. Until the 1950s, virtually all Christmas trees were obtained by individuals going to local forests to cut down their own. But that changed as increased demand from population growth and diminished supply from the loss of forests created a market opportunity. Seeing an ability to profit by growing and selling Christmas trees, farmers responded. Rather than venturing into the forest for a tree, you now have a wide range of tree sizes and varieties to choose from—all available close to home. In 2013, nearly 25 million farmed trees were sold in the United States for a total of over $1 billion.

Note that the supply of Christmas trees is relatively price inelastic for two reasons: it takes time to acquire land for planting, and it takes time for the trees to grow. However, these limits apply only in the short run. Over time, farms that are already in operation can increase their capacity and new tree farmers can enter the business. And, over time, the trees will mature and be ready to harvest. So the increase in the quantity supplied in response to an increase in price will be much larger in the long run than in the short run.

Where does the supply curve come from? Why is there a difference between the short-run and the long-run supply curve? In this chapter we will use our understanding of costs, developed in Chapter 6, as the basis for an analysis of the supply curve. As we’ll see, this will require that we understand the behavior both of individual firms and of an entire industry, composed of these many individual firms.

Our analysis in this chapter assumes that the industry in question is characterized by perfect competition. We begin by explaining the concept of perfect competition, providing a brief introduction to the conditions that give rise to a perfectly competitive industry. We then show how a producer under perfect competition decides how much to produce. Finally, we use the cost curves of the individual producers to derive the industry supply curve under perfect competition.

By analyzing the way a competitive industry evolves over time, we will come to understand the distinction between the short-run and long-run effects of changes in demand on a competitive industry—for example, how America’s preference for readily available trees for the holidays affected the Christmas tree farming industry. We will conclude with a deeper discussion of the conditions necessary for an industry to be perfectly competitive.