Long-Run Industry Supply Curve

Long-Run Industry Supply Curve

Long-Run Industry Supply Curve How does an industry respond to long-term changes in demand? The answer depends on how costs change as the industry expands. This determines the shape of the long-run supply curve.

Industry with Constant Costs (Constant-Cost Industry): expansion of the industry does not affect resource prices and firm costs.

Conditions:

• Industry is a small part of resource markets
• Resources are widely available

Long-run supply curve: a horizontal line at the minimum LRAC.

Mechanism:

• Increase in demand → in the short run, price rises, profit occurs
• Entry of new firms
• Costs do not change (resources are cheap)
• Price returns to the same minimum LRAC

Result: more output at the same price

Industry with Increasing Costs (Increasing-Cost Industry): expansion of the industry raises resource prices and costs.

Conditions:

• Industry is a large buyer of specific resources
• Resources are limited or have rising extraction costs

Long-run supply curve: upward-sloping (positive slope).

Mechanism:

• Increase in demand → entry of new firms
• Demand for resources increases → resource prices rise
• Costs of all firms rise → LRAC shifts upward
• New equilibrium at a higher price

Result: more output at a higher price

Examples: oil extraction (best fields become depleted), agriculture (fertile land is limited).

Industry with Decreasing Costs (Decreasing-Cost Industry): expansion of the industry reduces costs.

Conditions:

• Economies of scale in supplying industries
• Development of infrastructure, learning
• Network effects

Long-run supply curve: downward-sloping (negative slope).

Mechanism:

• Increase in demand → entry of new firms
• Supplying industries achieve scale → resource prices fall
• Costs decrease → LRAC shifts downward
• New equilibrium at a lower price

Examples: technology industries (components become cheaper with scale), young industries (learning curve).

Practical Implications

For pricing:

• In industries with increasing costs — prices rise with expansion
• In industries with decreasing costs — prices fall (technology, electronics)

For forecasting:

• The type of industry determines long-term price dynamics
• Commodity: prices reflect the costs of the marginal producer
• Technology: expect prices to fall as the market grows

For investor:

• Increasing-cost: advantage for low-cost producers
• Decreasing-cost: early leaders can secure an advantage
• Constant-cost: competition on efficiency, low margins

Producer Rents

In an increasing-cost industry, different producers have different costs:

• Inframarginal producers: those whose costs are below the market price. Receive rent (producer surplus).
• Marginal producer: one whose costs equal the market price. Zero economic profit.

Sources of rent:

• Best resources (fertile land, rich field)
• Best technologies
• Location

Rent vs. profit: rent is income from a limited resource. In long-run competitive equilibrium, rent exists; economic profit does not.