INCREASING AND AND DECREASING COST INDUSTRIES Increasing Cost Industries An industry industry for which the costs of production production increase increase as the the number of of companies companies involved with that industry increases. An increasing cost industry results results from an increase in producers which results in an increase in supply which causes a greater demand for the resources, which causes prices for resources to go up, which is why the costs for the industry as a whole are increasing. There are two reasons why the firms’ costs increase as they decide to produce more: •
•
Increasing input prices . As an industry grows, it competes with other industries for limited production resources. When the demand for these resources goes up, so do their prices. As we know, know, an increase increase in the prices of inputs inputs increases increases the firms’ production production costs. costs. Less productive inputs . As an industry grows, the producers are forced use the resources that are less well suited for the production of their output (for eample, less skillful employees!. As a result of this, the firms’ unit costs go up.
Example: "irst #emand The The per perfe fect ctly ly com compe peti titi tive ve $had $hady y %a %alley lley &uc &ucch chin inii mark market et increasing'cost industry. The original market euilibrium is presented in the ehibit to the right, with the supply curve $ and the demand curve #. curve #. The market euilibrium price is )e and the euilibrium The first step in identifying the long'run industry supply increasing'cost industry is with an increase in demand. with the increase in demand, the market price of &ucchinis increases to )e and the euilibrium uantity rises to *e.
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The higher price and larger uantity are achieved as each eisting firm in the industry responds to the demand shock. The higher price that buyers are willing to pay induces eisting firms to increase their uantities supplied as they move along their individual marginal cost curves. The market, as such, moves along the original market supply curve from one euilibrium point to a higher euilibrium point. -owever, the higher price leads to above'normal economic profit for eisting firms. And with freedom of entry and eit, economic profit attracts kumuat, cucumber, and carrot producers into this &ucchini industry. An increase in the number of firms in the &ucch ini industry then causes the market supply curve to shift. -ow far this curve shifts and where it intersects the new demand curve, #, determines that the &ucchini market is an increasing'cost industry.
The $upply esponse /conomic profit induces non'&ucchini firms to enter the #an the kumuat man begin producing &ucchinis. As these new firms enter the &ucchini industry, the market supply curve shifts rightward. This new supply curve intersects the new demand curve, #, at the euilibrium price of )o and the euilibrium uantity of *o. The key for an increasing'cost industry is how far the supply curve shifts. "or an increasing'cost industry the shift is not very far. As new firms enter the industry, they bid up the resource prices and cause higher production cost. )erhaps the price of &ucchini seeds rises. 0aybe the price of &ucchini &ucchini shovels is higher.
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Whatever the actual resource price, the end result is that the long'run average cost curve shifts upward. The minimum efficient scale for a given perfectly competitive firm is now at a higher cost. This means that they cannot produce the etra uantity demanded by the &ucchini buyers at the same per unit cost that had prevailed. The main point of interest is that the new euilibrium price is higher than the original. The positive slope of this long'run industry supply curve (1$! indicates an increasing'cost industry.
Decreasing cost industries A decreasing cost industry is one where costs decrease as the industry epands. 2n this case the industrys long run supply curve slopes downward: as the industry produces more output, the minimum average cost of production for each firm decreases with the decrease in costs. "irms in a decreasing cost industry do not necessarily have economies of scale in production3 the decrease in costs may reflect lower input costs which reduce the minimum point of the average total cost curve as the industry grows. 2nput costs may decline as the industry epands if there are economies of scale in the production of an important input. The primary reason for a decreasing'cost industry is an increase in demand triggers lower production cost and a downward shift of the long'run average cost curve as new firms entering the industry force down the prices of key resources. This could be because a key resource is able to take advantage of economies of scale or decreasing average cost in it is own production and supply. The entry of new firms into the cable television industry might, for eample, enable lower cost of using communication satellites. The entry of new firms into the manufacturing industry in a given city might enable a lower cost of electricity. irst Demand The perfectly competitive $hady %alley &ucchini market can be used to illustrate a decreasing' cost industry. The original market euilibrium is presented in the ehibit to the right, with the supply curve $ and the demand curve #. The market euilibrium price is )e and the euilibrium uantity is *e.
The !irst step in identifying the long'run industry supply curve for a decreasing'cost industry is with an increase in demand. +ote that with the increase in demand, the market price of &ucchinis increases to )e and the euilibrium uantity rises to *e.
The higher price and larger uantity are achieved as each eisting firm in the industry responds to the demand shock. The higher price that buyers are willing to pay induces eisting firms to increase their uantities supplied as they move along their individual marginal cost curves. The market, as such, moves along the original market supply curve from one euilibrium point to a higher euilibrium point. -owever, the higher price leads to above'normal economic profit for eisting firms. And with freedom of entry and eit, economic profit attracts kumuat, cucumber, and carrot producers into this &ucchini industry. An increase in the number of firms in the &ucchini industry then causes the market supply curve to shift. -ow far this curve shifts and where it intersects the new demand curve, #, determines that the &ucchini market is a decreasing'cost industry. T"e supply response /conomic profit induces non'&ucchini firms to enter the &ucchini industry. )eople like #an the kumuat man begin producing &ucchinis. As this new firms enter the &ucchini industry, the market supply curve shifts rightward. This new supply curve intersects the new demand curve, #, at the euilibrium price of )o and the euilibrium uantity of *o.
The key for a decreasing'cost industry is how far the supply curve shifts. "or a decreasing'cost industry the shift is relatively far. As new firms enter the industry, they force down the resource prices and enable lower production cost. )erhaps the price of &ucchini seeds falls. 0aybe the price of &ucchini fertili&er or &ucchini shovels is lower. Whatever the actual resource price, the end result is that the long'run average cost curve shifts downward. The minimum efficient scale for a given perfectly competitive firm is now at a lower cost. This means that they can produce the etra uantity demanded by the &ucchini buyers at a lower per unit cost than had prevailed. The main point of interest is that the new euilibrium price is lower than the original. To display the resulting long'run supply curve for this decreasing cost industry clicks the 41ong'un $upply 5urve6 button. The negative slope of the long'run industry supply curve (1$! indicates a decreasing'cost industry.
