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12.6 Long-Run Supply

The shape of the long-run supply curve depends on the extent to which input cost change when there is entry or exit of firms in the industry. We consider three types of cost conditions: constant-cost industries, increasing-cost industries and decreasing-cost industries.

In a constant-cost industry, the prices of inputs do not change as output is expanded. The industry does not use inputs in sufficient quantities to affect input prices.

Because the industry is one of constant costs, industry expansion does not alter firms’ cost curves, and the industry long run supply curve is horizontal. That is, once the short-run higher profits from an increase in demand has attracted entry until long run-equilibrium is again reached, the long‑run equilibrium price is at the same level that prevailed before demand increased; the only long‑run effect of the increase in demand is an increase in industry output.

Exhibit 1: Demand Increase in a Constant-Cost Industry

In an increasing-cost industry, the cost curves of the indi­vidual firms rise as the total output of the industry increases. When an industry utilizes a large portion of an input, input prices will rise when the industry uses more of that input as it expands output, which will shift firms’ cost curves upward. Once the short-run higher profits from an increase in demand has attracted entry until long run-equilibrium is again reached, producers’ MC and AC curves will be higher, so that the new long-run equilibrium is at a higher price. The long-run industry supply curve in this case has a positive slope.

Exhibit 2: Increasing-Cost Industry

Expansion in the output of an industry can lead to a reduction in input costs and shift the MC and ATC curves downward. Since a firm experiences lower costs as industry expands, the new long-run equilibrium has more output at a lower price—the long-run supply curve for a decreasing-cost industry is downward sloping (not illustrated).

As a practical matter, decreasing-cost industries are rarely encountered over a large range of output. However, some industries may operate under decreasing-cost conditions when continued growth makes possible the supply of materials or services at reduced costs

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Productive efficiency requires that firms produce in the least costly way, where P = minimum ATC.

The output that results from equilibrium conditions of market demand and market supply in perfectly competitive markets is economically efficient. Producers used their scarce resources to produce what consumers want, achieving allocative efficiency.

Exhibit 3: Allocative Efficiency and Perfect Competition