How will cost influence supply?
Economists are interested in cost because they seek to explain firms’ supply decisions. A strictly profit-maximizing firm will compare the expected revenues derived from a decision or a course of action with the expected costs. If the expected revenues exceed costs, then the course of action will be chosen because it will expand profits (or reduce losses).
For short-run supply decisions, the marginal cost of producing additional units is what should be considered. To maximize profits, the decision maker should compare the expected marginal costs with the expected additional revenue from larger sales. If the latter exceeds the former, output (the quantity supplied) should be expanded.
Marginal costs are central to the choice of short-run output, whereas expected average total cost is vital to a firm’s long-run supply decision. Before entering an industry (or purchasing capital assets for expansion or replacement), a profit-maximizing decision maker will compare the expected market price with the expected long-run average total cost. Profit-seeking potential entrants will supply the product if, and only if, they expect the market price to exceed their long-run average total cost. Similarly, existing firms will continue to supply a product in the long run only if they expect that the market price will enable them at least to cover their long-run average total cost.
Economists are interested in cost because they seek to explain firms’ supply decisions. A strictly profit-maximizing firm will compare the expected revenues derived from a decision or a course of action with the expected costs. If the expected revenues exceed costs, then the course of action will be chosen because it will expand profits (or reduce losses).
For short-run supply decisions, the marginal cost of producing additional units is what should be considered. To maximize profits, the decision maker should compare the expected marginal costs with the expected additional revenue from larger sales. If the latter exceeds the former, output (the quantity supplied) should be expanded.
Marginal costs are central to the choice of short-run output, whereas expected average total cost is vital to a firm’s long-run supply decision. Before entering an industry (or purchasing capital assets for expansion or replacement), a profit-maximizing decision maker will compare the expected market price with the expected long-run average total cost. Profit-seeking potential entrants will supply the product if, and only if, they expect the market price to exceed their long-run average total cost. Similarly, existing firms will continue to supply a product in the long run only if they expect that the market price will enable them at least to cover their long-run average total cost.