Science, Tech, Math › Social Sciences The Long-Run Supply Curve Share Flipboard Email Print Social Sciences Economics U.S. Economy Employment Supply & Demand Psychology Sociology Archaeology Environment Ergonomics Maritime By Jodi Beggs Economics Expert Ph.D., Business Economics, Harvard University M.A., Economics, Harvard University B.S., Massachusetts Institute of Technology Jodi Beggs, Ph.D., is an economist and data scientist. She teaches economics at Harvard and serves as a subject-matter expert for media outlets including Reuters, BBC, and Slate. our editorial process Jodi Beggs Updated March 06, 2017 01 of 08 The Short Run Versus the Long Run There are a number of ways to distinguish the short run from the long run in economics, but the one most relevant to understanding market supply is that, in the short run, the number of firms in a market is fixed, whereas firms can fully enter and exit a market in the long run. (Firms can shut down and produce a quantity of zero in the short run, but they can't escape their fixed costs and can't fully get out of a market.) While determining what firm and market supply curves look like in the short run is pretty straightforward, it's also important to understand the long-run dynamics of price and quantity in competitive markets. This is given by the long-run market supply curve. 02 of 08 Market Entry and Exit Since firms can enter and exit a market in the long run, it's important to understand the incentives that would make a firm want to do so. Put simply, firms want to enter a market when the firms currently in the market are making positive economic profits, and firms want to exit a market when they are making negative economic profits. In other words, firms want to get in on the action when there are positive economic profits to be made, since positive economic profits indicate that a firm could do better than the status quo by entering the market. Similarly, firms want to go do something else when they are making negative economic profits since, by definition, there are opportunities for more profit elsewhere. The reasoning above also implies that the number of firms in a competitive market will be stable (i.e. there will be neither entry nor exit) when firms in the market are making zero economic profit. Intuitively, there will be no entry or exit because economic profits of zero indicate that firms are doing no better and no worse than they could in a different market. 03 of 08 The Effect of Entry on Prices and Profits Even though one firm's production doesn't have a noticeable impact on a competitive market, a number of new firms entering will in fact significantly increase market supply and shift the short-run market supply curve to the right. As comparative statics analysis suggests, this will put downward pressure on prices and therefore on firm profits. 04 of 08 The Effect of Exit on Prices and Profits Similarly, even though one firm's production doesn't have a noticeable impact on a competitive market, a number of new firms exiting will in fact significantly decrease market supply and shift the short-run market supply curve to the left. As comparative statics analysis suggests, this will put upward pressure on prices and therefore on firm profits. 05 of 08 Short-Run Response to a Change in Demand In order to understand short-run versus long-run market dynamics, it's helpful to analyze how markets respond to a change in demand. As a first case, let's consider an increase in demand. furthermore, let's assume that a market is originally in a long-run equilibrium. when demand increases, the short-run response is for prices to increase, which increases the quantity that each firm produces and gives firms positive economic profits. 06 of 08 Long-run Response to a Change in Demand In the long run, these positive economic profits cause other firms to enter the market, increasing market supply and pushing profits down. Entry will continue until profits are back at zero, which implies that the market price will adjust until it returns to its original value as well. 07 of 08 The Shape of the Long-Run Supply Curve If positive profits cause entry in the long run, which pushes profits down, and negative profits cause exit, which pushes profits up, it must be the case that, in the long run, economic profits are zero for firms in competitive markets. (Note, however, that accounting profits can still be positive, of course.) The relationship between price and profit in competitive markets implies that there is only one price at which a firm will make zero economic profit, so, if all firms in a market face the same costs of production, there is only one market price that will be sustained in the long run. Therefore, the long-run supply curve will be perfectly elastic (i.e. horizontal) at this long-run equilibrium price. From the perspective of an individual firm, price and quantity produced will always be the same in the long run, even as demand changes. Because of this, points that are further out on the long-run supply curve correspond to scenarios where there are more firms in the market, not where individual firms are producing more. 08 of 08 An Upward-Sloping Long-Run Supply Curve If some firms in a competitive market enjoy cost advantages (i.e. have lower costs than other firms in the market) that can't be replicated, they will be able to sustain positive economic profit, even in the long run. In these cases, the market price is at he level where the highest cost firm in the market is making zero economic profit, and the long-run supply curve does slope upwards, though it is usually still fairly elastic in these situations.