Question

Show an example of a decreasing cost industry in the long run between a firm and the market. Assume the firm is at zero profit in the initial equilibrium, followed by an increase in market demand. Assume the firm is at zero profit in the initial equilibrium, followed by an increase in market demand.

Answer 1

A DECREASING COST INDUSTRY is one in which input price decrease with increase in production thus reducing the average costs and marginal costs for the individual and market which drives the price down and increases the sales and revenue.

In the FIRST DIAGRAM, the market was in equilibrium with individual firm earning zero economic profit where demand curve/ LMR=LMC=LAC.

In the SECOND DIAGRAM,with increase in demand , demand curve shifts right so to meet demand, supply curve also shifts right and in the short run effect is shown in which price and quantity go up in short run because in short run, price of inputs dont change. So, in short run firm earns abnormal profits. But short run analysis is essential in drawing the long run supply curve which is just like the demand curve because with increase in supply, price decreases as input prices go down in a DECREASING COST INDUSTRY. the point of intersection of S1 and P1 curve on to the D1 is the point from where long run supply curve of market passes through and Q2 level is achieved and P2 prices are determined. E0 to E2 shows the market supply curve . AND in long run the individual shifts to lower marginal cost and average cost curves which also decreases per unit price and increases equilibrium quantity at new lower equilibrium prices.

THEREFORE, IT IS IMPERATIVE TO FIRST SHOW SHORT RUN IMPACT TO REACH TO THE LONG RUN IMPACT .

In the THIRD DIAGRAM, we seperated the long run effects for better understanding of what the long run impact is otherwise only the first 2 diagrams are to be made.

REFER TO THE DIAGRAMS AND FIRST READ THE SHORT RUN IMPACTS OF E0 TO E1 AND THEN E0 TO E2 I.E., LONG RUN. (FOR ANY DOUBTS DROP A COMMENT)