Question

What factors influence the shape of a firm’s marginal cost curve? How does this curve relate to the firm’s supply curve and the price elasticity of supply?

Answer 1

The marginal cost curve  is U in the short run because of law of diminishing returns. At this stage total cost as well as variable cost begin to increase but at a diminishing rate, because of the specialization of resources and marginal cost fall till it reaches to its minimum point.

Determinants of firm's supply curve:

Supply curve of a firm is a part of MC curve. Therefore, any factor that affects the MC curve will definitely be the determinant of the supply curve. Price of commodity, technology of production, input costs and unit tax are the important factors that affect supply curve. We shall now discuss how these factors influence the supply curve.

1. Price of the commodity: The most important factor that determines supply of a commodity is its price. There is a direct positive relation between price and quantity supplied. When price of commodity rises, its quantity supplied also rises and vice versa.

2. Technology of production: Suppose a firm uses capital and labor as factors of production to produce a certain good.With improved technology or innovation, a firm can produce more units of output with the same level of input or same level of output with less amount of input.When improved technology is used, MC decreases and the supply curve shifts to the right or downwards. On the other hand,when outdated technology is used MC increases and the supply curve shifts to the left or upwards.At any given market price the firm can supply more units of output .

3.Input prices: The supply of a firm is influenced by the prices of inputs.If input prices go down, MC will decrease.As a result the supply curve will shift to the right. Similarly if input prices go up, MC will increase and the supply curve will shift to the left. At any given market price, the firm can supply lower units of output.

4. Unit tax: A unit tax is a tax that the government imposes per unit sale of output. When unit tax is increased MC increases and the supply curve shifts to the left.Similarly, when unit tax is reduced the supply curve shifts to the right.

Price elasticity of supply is defined as the degree of responsiveness of quantity supplied of a commodity with respect to change in its price.This can be calculated by dividing the percentage change in supply by the percentage change in price.