In this lesson, we described the source of the supply curve, which is basically a functional relationship that defines the minimum amount of money a firm can charge for a certain amount of some good it is selling in a market place.
It turns out that the supply curve is defined by the marginal cost of a good, which means that if a firm makes one more unit of a good, they must be willing to sell it for at least the cost of making that unit. Included in the marginal cost is an amount that is equivalent to a necessary return to an owner, sufficient to make a person want to invest in a certain industry. This is the amount that yields "zero economic profit," which simply means that a firm in a specific industry is generating an accounting profit that is sufficient to provide a return on investment that equals the risk-free rate plus the appropriate risk premium for the industry in question.
When the supply curve is plotted on the same diagram as a demand curve, we have a "supply and demand" diagram, and the point at which the supply and demand curves intersect is called the "market equilibrium." It is the price and quantity sold that we expect to see in a perfectly competitive market at a given point in time.
A perfectly competitive market is one in which our four assumptions of perfect competition are met:
- No market power
- Perfect information
- Product homogeneity
- Free entry and exit
These four conditions are rarely met in real life. Any deviation from this condition is called a "market failure." We will spend much of the rest of the course studying market failures, and the problems that are associated with governments trying to fix market failures, which we call "government failure."
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You have reached the end of Lesson 3! Double check the list of requirements on the first page of this lesson to make sure you have completed all of the activities listed there.
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