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INCREASING AND DECREASING COST INDUSTRIES

Increasing Cost Industries


An industry for which the costs of production increase as the number of companies
involved with that industry increases.
An increasing cost industry 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, 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'.

can be used to illustrate an

quantity is Qe.
curve for an
Note that

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 an increasing-cost industry.

The Supply Response


Economic profit induces non-zucchini firms to enter the
Dan the kumquat man begin producing zucchinis. As these
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 an increasing-cost industry is how far the supply
curve shifts. For 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. Perhaps
the price of zucchini seeds rises. Maybe the price of zucchini
zucchini shovels is higher.

zucchini industry. People like

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.

Decreasing cost industries


A decreasing cost industry is one where costs decrease as the industry expands. In this case
the industry's 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.
Firms in a decreasing cost industry do not necessarily have economies of scale in production;
the decrease in costs may reflect lower input costs which reduce the minimum point of the
average total cost curve as the industry grows. Input costs may decline as the industry expands
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 example, 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.
First Demand
The perfectly competitive Shady Valley zucchini market can be used to illustrate a decreasingcost 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 quantity is Qe.

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.