After analysis it can be found a firm’s supply curve as well as addition of all the company’s supply curve came down to total supply curve. However, in case of long run situation, firms can surely enter and leave the market as per price change in the market and therefore analysis of long run supply curve cannot be done. So, supply curves cannot be added up and hence so total market supply is not found in case of such firms.
It is this increase and decrease of output levels that determine the shape of long run supply curves that are associated with a firm. Also, firms should pay up for inputs while production process is carried on. In case a large number of inputs has to be procured, with rise in output prices input prices fall. Also, at times with change in output input prices will not change and to get the long term production rates in hand, it is assumed that all the firms have production technology. Also, it is to be noted that there is no change in market scenario and union does not get a chance to determine labor costs with increased supply.
There are 3 types of industries that such curves can distinguish, and these are: increasing cost, constant cost and decreasing cost.
The scenario of a constant cost industry
In the diagram 8.16 the supply curve’s derivation is shown in the long run for an industry having constant cost. The output choice of the firm is given by (a) and through (b) the industry output is depicted. Where the intersections of the supply curve in short run shown by S1 and the demand curve for the market D1 is shown, this is the situation when the market is initially at the stage of equilibrium. There is a point named A at the intersection of the demand and the supply curve and it is shown on the supply curve SL in the long run and this tells that when in the long run the equilibrium price will be P1 then the industry will be producing Q1 units of output.
Let’s say that due to a situation like reduction in the income taxes of people, product demands in market increases unexpectedly and there arises a need to obtain all the other points related to the supply curve in the long run. Any typical firm will be at a level where it will be producing an output level q1 units and P1 will be the equivalent for average cost in the long run and marginal cost in the long run. But due to the condition that the company is also seeing the situation of short run equilibrium then the price will be equivalent to the marginal cost in the short run. Market demand curve moves from D1 to D2 due to the tax cut. The supply curve S1 cuts the demand curve D2 at point C. Due to this effect the price rises from P1 to P2 level. The part (a) depicts in the diagram 8.16 that how the increase in prices will be affecting a typical firm that is there in industry. When this price raises to a level of P2 the firm will be following the marginal cost curve in the short run and the output will be increased to an output of Q2. This particular output choice will help in maximization of the profits as it is able to satisfy the criteria that the price is equivalent to the marginal cost in the short run. Each firm will be enjoying positive profits in the short run equilibrium if it responds in this particular way. The profit that will be generated will act like an attraction for the investors and it will lead to a situation that the existing firms are able to achieve the expansion of their operations and the new firms are able to arrive in the market. Due to this condition the supply curve in the short run shifts from S1 to S2 in the right direction as shown in the figure 8.16. Due to this shift the market is able to move to a newly created equilibrium for the long run existing at the point of intersection of the S2 and D2. Output should be expanded enough in order the firms are at the position of zero economic profit and also the incentive either to exit or to arrive in the market will not be seen, for the case of this intersection resulting in long term equilibrium.
In the scenario attributable to the industry based on constant cost the additional inputs which are required for producing the increased output can be bought without a rise in the per unit cost. Such a situation can occur if in case the unskilled labor is one of the vital inputs associated with the production process and the wage rate in the market of the labors that are unskilled remains to be unaltered with a rise in labor demand. But as the input prices have remained the same, therefore the cost curves related to the firm will also remain unchanged. The situation of the new equilibrium will be obtained at the point B depicted by the diagram 8.16 part b where the price will be equal to a level P1, which is the level of original price which occurred prior to the sudden rise in demand.
Thus for the constant cost industry the supply curve in the long run is present as horizontal line where rate is similar to lowestaverage cost of production in the long run. If the price will be even a bit higher then it will be a situation amounting to positive profit, more entry by new firms, higher case of supply in the short run, and eventually resulting in the downward pressure on the price factor. One should pay attention that in the case of industry having constant cost the prices of input remains the same when the circumstances in the output market vary. So the average cost curves in the long run related to the constant cost industries can be horizontal in nature.
The scenario of an increasing cost industry
The industry in which there is a situation of increasing costs, there the prices of all or some of the inputs that are related to the production process will rise with the expansion process of the industry and the demand for inputs will also increase. The explanation can be associated with the process of diseconomies of scale associated with the production of either one or several inputs. Let’s say that skilled labor is being used in the industry and its supply is short, thus the demand for it will naturally rise. Or it can be a case that a firm needs certain specific mineral based resources which will be only found in a particular type of land; therefore the cost associated with the land which is an input in this case will be increasing with the level of output. In the diagram 8.17 it has been clearly illustrated the derivation process of supply curve in the long run which is very much like the earlier case of derivation of the constant cost. Talking about the industry it is seen at the position of equilibrium at point A in the part b. Due to the unexpected shift of the demand curve from the level D1 to the level D2, there is an increase in the product price to P2 in the short run and the output of the industry is raised from the existing level of Q1 to the new level of Q2. In the case of a typical firm as depicted by part (a), it will increase its level of output from q1 to the level of q2, due to the increased price with the option of going along the marginal cost curve in the short run. Because of the more profits which are gathered by this and all the other firms in the market it will induce the various firms to enter into the industry.
Due to the reason that new firms have entered the industry and the level of output has considerably expanded, there will be more demand for the inputs and it will cause either rise in the prices of all or some the inputs required in the production process. This supply curve for market in the short run will shift in the right direction as it did previously, but it will not move that much in this case, and there will a point B that denotes the new equilibrium and the resultant price obtained will be P3 that will be higher as compared to the initial level of price which was P1. Due to the increased costs of the inputs, the short run as well as the long run cost curves of the firm will be raised, therefore subsequently market price also needs to be higher so that it is ensured that all the firms are at the level of zero profit in the situation of long run equilibrium.
In the diagram 8.17 this condition is clearly shown. There will be an upwards shift in the average cost curve from the level of AC1 to the level of AC2 and talking about the marginal cost curves they will be shifting in the leftwards direction from the position of MC1 to the new position of MC2. The newly formed case of price level P3 in the long run equilibrium is equivalent to the new level of the minimum average cost which is increasing in nature. It was seen in the case of constant cost that the increased amount of the profits in the short run which were a result of the starting rise in the demand will eventually fade away in the case of long run when the firms will be raising their levels of output and the costs associated with the inputs will rise.
The point B depicts the new equilibrium in the diagram 8.17 part (b), and this point is achieved on the supply curve in the long run for the industry. Where an increasing cost associated industry is present, long run supply curve for such an industry will be upward sloping in nature. The industry as a whole will be able to produce much higher output but the price level will also go up because now the costs of the inputs has increased. When the term increasing cost is referred then it means that there is an upward shift in average long run cost curve of the firm but not referring to that positive line related to the cost curve in the general sense.
The scenario of a decreasing cost industry
The supply curve for an industry can also slope in the downwards direction. In such a situation the rise in the demand unexpectedly will cause the industry to expand its output as earlier. But when the circumstances will arise that the industry will further see more growth then it can avail certain advantages in the way by which it can procure certain inputs at considerable cheaper prices. Let’s say that an industry that is bigger in size can provide the facility of improvised system of transportation or a network for financial needs which is better as well as less expensive.
Even if the firms in this case are not enjoying the economies of scale still then the average cost curves for the firm will be shifting in the downwards position. There will be a drop in the market value of the product. Now due to the decreased market price as well as the reduced average cost of production, will result in the new long run equilibrium where there will be increased number of firms, greater output, and reduced price level. Thus if the industry is a decreasing cost one then in such a case the associated supply curve in the long run for the industry will be sloping in the downwards direction.
The implications associated with tax
It was observed in lesson 7 that if tax is imposed on one of the inputs of the firm by the way of effluent fee, then it leads to the creation of an incentive for the firm in such a way that it modifies the manner it is utilizing the inputs in the process attributed for production. Let us see the different ways by which a particular firm will behave when tax is levied on its output. To ease out the process of understanding we take the condition that the fixed proportion technology is used in the production process by the firm. There can be a case that the tax levied on the output will inspire the firm to decrease the level of the output in case if it is a polluter. And thus the effluent or as the case may be levied just to raise the level of revenue.
Let us assume that initially the output tax is levied just on this firm and hence the market price of this product is not going to be affected. One can notice that due to putting of the tax on the output, it will persuade the firm that it lowers down its output level. It is depicted with the help of diagram 8.18, the associated cost curves in the short run for the firm that is availing the benefits of surplus economic profit by engaging itself in the production of an output level of q1 quantity and eventually selling the product at a price level of P1 in the market. It is seen that the tax will be evaluated for each and every unit related to the output, thus it will make the marginal cost curve of the firm to rise from MC1 to MC2_MC1_t and here t represents tax for each unit related to the output of firm. It is due to the tax that the average variable cost is raised by the value t.
There can be two visible effects due to this output tax. If the condition of the firm is such that after the levying of taxes it is able to enjoy the benefits of positive profits or zero economic profit, then it can choose to maximize the earnings by selecting that level of output where the sum of marginal cost and the tax is equivalent to the product’s price. There is reduction in the output level from q1 to q2 and due to the corresponding effect due to tax the supply curve will be shifting in the upwards direction which will be representing the amount of tax which has been imposed. But if there is a case that the firm is unable to earn any economic profit because of the imposition of tax then it will opt for the strategy of exiting the market. Now the new situation is there when tax is imposed on each and every single company in the market and thus the marginal costs will be increasing. So in this case every firm will reduce the output level at the prevailing market price and eventually the aggregate output which is being provided by the frim will fall to a considerable level and thus ultimately the price of the product will rise. It is shown in diagram 8.19. The supply curve moves in the upward direction from the level S1 to the level S2_S1_t, thus leading to an increase in the market price of product from level P1 to level P2 (this increase in the level of price is lower than the amount of tax). Due to this price increase some of the consequences as seen earlier are diminished. The firms will be decreasing their level of output less than they might actually have done, if the increase in price was not there.
But those firms whose costs are bit higher as compared to the other firms may wish to exit this industry because of such output based tax. In the end of this process due to the effect of tax the long run average cost curve will get raised for each and every firm operating in such an industry.
Elasticity of supply in the long run
When it comes to defining the elasticity of supply in the long run for an industry it is very much similar to the elasticity of supply in the short run. It can be described as the percentage change resulting in the output i.e. denoted by _Q/Q which occurs because of the percentage change in the level of the prices i.e. is denoted by _P/P. If the industry is a constant cost based, the supply curve in the long run is going to be horizontal and thus the elasticity of the supply is large at an infinite level. It actually tells that even a little increase in the level of price will lead to a massive increase in the level of output.
If the market is entirely based on the increasing cost then the supply curve’s elasticity in the long run will be positive in nature but its level will be a finite one. Due to the reason that industries in the long run can easily adjust and expand in the way they want, one can expect that the long run supply elasticity will be large when compared to the short run elasticity of supply. The scale of the elasticity of supply will be based upon the degree by which the costs associated with the inputs are rising when the market is seeing the stage of expansion. Let’s say that an industry is making the use of such inputs which are easily available, and then in such a case the supply curve in the long run will be more elastic as compared to an industry that has a limited supply of the inputs that it requires.
Links of Previous Main Topic:-
- Introduction Markets and Prices Preliminaries
- The Basics of Supply And Demand
- Consumer Behavior
- Appendix to Chapter 4 Demand Theory a Mathematical Treatment
- Uncertainty and Consumer Behavior
- The Cost of Production
- Production and Cost Theory A Mathematical Treatment
- Cost in the Long Run
- The Cost of Production Production with Two Outputs
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