Long-run Normal Price i ll Increasing Cost Industry
As we explained in the previous chapter, supply curve of an increasing-cost industry slopes upwards from left to right. This is so because when a full-sized industry expands as a result of the increased demand for its product, it experiences certain external economics and diseconomies. But external dis economies in the case of an increasing-cost industry outweigh the external economics aim this brings about an upward shift in the cost curves of all Finns. Whup the industry expands, the costs rise primarily due to the intensive bidding of the prices of specialist ed labor and raw materials by new firms. As already expedience, the increasing -cost industry i~ the most typical of the actual competitive world. The whole pricing process in the long-run supply curve of the increasing-cost industry. MPS is the market period supply CUI vc and SRS the short-run supply curve. To begin with, DD is the market demand curve and 01′ is the market price. Now suppose that there is a sudden and once-for-all increase in demand from DD D’ D’. In the market period or very short-run. the firms call sell only Whitley have already Piccadilly.
The total amount supplied will remain unchanged at output OM. Thus. as a result of increase in demand from DD to D’ D’, the kick price will rise sharply from 01′ to 01″, because the new demand curve I)’ I)’ intersects the market LCM supply curve MPS at 01′ level, In the short-run, however.the Iiru« will increase output UM 10 OM’ along the short-run marginal cost curve. Therefore, the price in the short-run will fall the level which the new DE ilia curve D’ D’ intersects the short-run supply curve SRS. which is the lateral simulation of the short-run marginal cost curves uf the firms. III this short-run equilibrium, cry will be producing output foil which the price or” is equal to short-run short run equilibrium position. ficus would be earning subnormal profits, because the price above the LAC (long-run average cost)l· Lured by these supplemental profits, new filling enter into the industry in the long-run. But since we are dealing with the increasing-cost industry, as the new firms enter, the cost curves of all the firms will shift upwards due to the net external dis economies. As the output of the industry increases OM to OM” as a result of the entry of new firms, price in the long-run will fall to OP'” at which the demand curve 0′ D’ intersects the long-run supply curve LRS. Thus, OP'” is the long-run normal price.This long-run normal price 01”” must be equal to the minimum long-run average cost since new firms will continue entering the industry until all firms are earning only normal pr fits. But this new minimum average cost in the case of increasing-cost industry will be higher than the initial minimum average cost, because costs have risen due to the entry of new firms in the industry. 1 therefore. the price 01”” will be higher than the initial price OP. From the above, it is clear that, in the long-run, n the case of increasing-cost industry, more quantity output can be got only at a rather higher price. e tent to which the long-run price differs from original price depends on the extent of increase in lowing the expansion of the industry. It must r lIy noted that each point on the long-run sup of the industry LRS represents a long -run the demand shirts to the right inducing e pan ion of tile industry, with more higher co t curves sion, external economics and diseconomies cancel each other so that the constituent finns of an enlarged industry do not experience shift in their cost curves. An industry can also be a constant-cost industry if its expansion breeds neither external economies nor external diseconomies. h was also pointed out in the preceding chapter that the long-run supply of the constant- cost industry is a horizontal straight line or perfectly elastic at the level of long-run minimum average cost, i.e., the bottom of the Ll-shaped LAC. The pricing process in a constant-cost industry can be explained. To begin with, DU is the demand curve and it intersects the market period supply curve MPS at price level 01′. Thus. 01′ is the market price.Now if the demand increases to D’ 0′, there will be a sharp rise in the market price from OJ> to Ol’ where the new demand. curve cuts the Market supply Curve (MPS), the supply remaining unchanged. In response to the increased demand. the firms in the short-run will increase production. Therefore. in the hort-run equilibrium, price will fall to at which the short-run supply curve SRS intersects the new demand curve D’ U’. In the long-run. the output will increase further and the price will fall to the original level. In the case of of a constant-cost industry. the new long-run normal price will he the same as the original equilibrium price OP. The output of the industry, in this new long nil! equilibrium. will be OM “,F.\’cr) linn in the II n, – run will be producing at the long-run minimum a age cost as in the original equip Thus, we see that, ill this constant-cost case, an increase or decrease in demand will. in the long-run, simply chung c output by changing the number or finns. It will haw effect on price in the long-run or on the scale and costs of each limn under perfect competition is always turned to the bottom of U-shaped LAC curve and no shift lakes place in cost curves in the constant cost industry.
Long-run Normal Price i ll Increasing Cost Industry