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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, an increase in the prices of inputs increases the firms production 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 example, less
skillful employees). As a result of this, the firms unit costs go up.
Example:
First Demand
The perfectly competitive Shady Valley zucchini market
increasing-cost industry. The original market
equilibrium is presented in the exhibit to the right, with
the supply curve S and the demand curve D. The
market equilibrium price is Pe and the equilibrium
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
zucchinis increases to Pe' and the equilibrium quantity
rises to Qe'.
quantity is Qe.
curve for an
Note that
fertilizer or
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 extra
quantity demanded by the zucchini buyers at the same per unit
cost that had prevailed.
The main point of interest is that the new equilibrium price is
higher than the original. The positive slope of this long-run
industry supply curve (LRS) indicates an increasing-cost
industry.
The first step in identifying the long-run industry supply curve for a decreasing-cost industry is
with an increase in demand. Note that with the increase in demand, the market price of
zucchinis increases to Pe' and the equilibrium quantity rises to Qe'.
The higher price and larger quantity are achieved as each existing firm in the industry responds
to the demand shock. The higher price that buyers are willing to pay induces existing firms to
increase their quantities supplied as they move along their individual marginal cost curves. The
market, as such, moves along the original market supply curve from one equilibrium point to a
higher equilibrium point.
However, the higher price leads to above-normal economic profit for existing firms. And with
freedom of entry and exit, economic profit attracts kumquat, cucumber, and carrot producers
into this zucchini industry. An increase in the number of firms in the zucchini industry then
causes the market supply curve to shift. How far this curve shifts and where it intersects the new
demand curve, D', determines that the zucchini market is a decreasing-cost industry.
The supply response
Economic profit induces non-zucchini firms to enter the zucchini industry. People like Dan the
kumquat man begin producing zucchinis. As this new firms enter the zucchini industry, the
market supply curve shifts rightward.
This new supply curve intersects the new demand curve, D', at the equilibrium price of Po and
the equilibrium quantity of Qo.
The key for a decreasing-cost industry is how far the supply curve shifts. For 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. Perhaps the price of zucchini seeds falls. Maybe the
price of zucchini fertilizer or zucchini 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 extra quantity demanded by the zucchini buyers at a
lower per unit cost than had prevailed.
The main point of interest is that the new equilibrium price is lower than the original. To display
the resulting long-run supply curve for this decreasing cost industry clicks the [Long-Run Supply
Curve] button. The negative slope of the long-run industry supply curve (LRS) indicates a
decreasing-cost industry.