The Industrys LongRun Supply Curve
In our analysis of short-run supply, we first derived the firm's supply curve and then showed how the horizontal summation of individual firms' supply curves generated a market supply curve. We cannot analyze long-run supply in the same way, however, because in the long run firms enter and exit the market as the market price changes. This makes it impossible to sum up supply curves-we don't know which firms' supplies to add.
To determine long-run supply, we assume all firms have access to the available production technology. Output is increased by using more inputs, not by invention. We also assume that the conditions underlying the market for inputs to production do not change when the industry expands or contracts. For example, an increased demand for labor does not increase a union's ability to negotiate a better wage contract for its workers.
The shape of the long-run supply curve depends on the extent to which increases and decreases in industry output affect the prices that the firms must
FIGURE 8.14 Firms Earn Zero .Profit in Long-Run Equilibrium. In long-run equilibrium, all firms earn zero economic profit. In (a) a baseball team in a city with other competitive sports teams sells enough tickets so that price ($7) is equal to marginal and average cost. In (b) there are no other competitors, so a $10 price can be charged. The team increases its sales to the point at which the average cost of production plus the average economic rent is equal to the ticket price. When the opportunity cost associated with owning the franchise is taken into account, the team earns zero economic profit.
pay for inputs into the production process. It is thus useful to distinguish among three types of industries: constant-cost, increasing-cost, and decreasing-cost
Constant-Cost Industry
Figure 8.15 shows the derivation of the long-run supply curve for a constant-cost industry. Assume that the industry is initially in long-run equilibrium at the intersection of market demand curve D\ and market supply curve Si, in part (b) of the figure. Point A at the intersection of demand and supply is on the long-run supply curve SLbecause it tells us that the industry will produce Qi units of output when the long-run equilibrium price is Pi.
To obtain other points on the long-run supply curve, suppose the market demand for the product unexpectedly increases, say because of a tax cut. A typical firm is initially producing at an output of <71, where Pi is equal to long-run marginal cost and long-run average cost. But the firm is also in short-run equilibrium, so that price also equals short-run marginal cost. Suppose that
FIGURE 8.15 Long-Run Supply in a Constant-Cost Industry. In (b) the long-run supply curve in a constant-cost industry is a horizontal line Sl. When demand increases, initially causing aprice rise, the firm, initially increases its 011 tpu t from <yi to qi in (a). But the entry of new firms causes a shift to the right in supply. Because input prices are unaffected by the increased output of the industry, entry occurs until the original price is obtained.
FIGURE 8.15 Long-Run Supply in a Constant-Cost Industry. In (b) the long-run supply curve in a constant-cost industry is a horizontal line Sl. When demand increases, initially causing aprice rise, the firm, initially increases its 011 tpu t from <yi to qi in (a). But the entry of new firms causes a shift to the right in supply. Because input prices are unaffected by the increased output of the industry, entry occurs until the original price is obtained.
the tax cut shifts the market demand curve from Di to D2. Demand curve Di intersects supply curve Si at C As a result,the price increases from Pi to P2.
Part (a) shows how this price increase affects a typical firm in the industry. When the price increases to P2, the firm follows its short-run marginal cost curve and increases its output to q2. This output choice maximizes profit because it satisfies the condition that price equal short-run marginal cost. If every firm responds this way, each firm will be earning a positive profit in short-run equilibrium. This profit will be attractive to investors and will cause existing firms to expand their operations and new firms to enter the market.
As a result, in Figure 8.15b the short-run supply curve shifts to the right, from Si to S2. This shift causes the market to move to a new long-run equilibrium at the intersection of D2 and S2. For this intersection to be a long-run equilibrium, output must expand just enough so that firms are earning zero profit and the incentive to enter or exit the industry disappears.
In a constant-cost industry, the additional inputs necessary to produce the higher output can be purchased without an increase in the per-unit price. This might happen, for example, if unskilled labor is a major input in production, and the market wage of unskilled labor is unaffected by the increase in the demand for labor. Since the prices of inputs have not changed, the firms' cost curves are also unchanged; the new equilibrium must be at a point such as B in Figure 8.15b, at which price is equal to Pi, the original price before the unexpected increase in demand occurred.
The long-run supply curvefor a constant-cost industry is, therefore, a horizontal line at a price that is equal to the long-run minimum average cost of production. At any higher price, there would be positive profit, increased entry, increased short-run supply, and thus downward pressure on price. Remember that in a constant-cost industry, input prices do not change when conditions change in the output market. Constant-cost industries can have horizontal long-run average cost curves.
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