Question

Give examples (real or hypothetical) of the following types of industries, paying special attention to discuss what is predicted to happen to price as more firms enter the market in the long-run. a. Constant cost b. Increasing cost c. Decreasing cost

Answer 1

a. In constant cost industry, the external economies exactly balance out the external diseconomies. It implies there is no change in cost. In other words, the additional inputs necessary to to produce higher output can be purchased without an increase in per unit price. The long run supply curve is a straight horizontal line.

An example of constant cost industry is the pencil industry. When the demand for pencils increase, the demand for wood will increase. Since pencil industry covers a very small proportion of wood demand, the price of wood does not change. This, in turn, does nkt affect the price of pencils.

b. In an increasing cost industry, the prices of some or all inputs to production increase as the industry expands and the demand for the input grows. Net external diseconomies prevail in this case. Due to this, price rises as the quantity rises and we get an upward sloping long run supply curve.

An example of increasing cost industry is the coal industry. As the demand for coal increases, the energy productions cost will rise. Because the industry faces higher production costs, companoes will charge higher price for their output.

c. In this case, net external economies prevail. Due to this, factor prices fall as more firms enter the market in the economy. This reduces the per unit price as the quantity increases. Due to this, the long run supply curve becomes downward sloping.

An example of decreasing cost industry is personal computers. An increase in demand for personal computers has led to lower prices in the market.