Assume you manage a company that manufactures and sells wooden jewelry on the domestic market. With time, the demand for wooden jewelry grows, and you begin to make huge profits. You decide to expand your firm because you believe you will be able to earn more profit. Or will you? Several other factors are influencing the industry as market conditions change. The answer will depend on whether your company operates in an increasing, decreasing, or constant cost industry. To find out more, let's get straight into the article!
Constant Cost Industry Definition
Before we get into the constant cost industry, let's have a quick look at the industry's long-run supply curve. In the long run, the market price fluctuates, which causes various companies to enter and exit the market. Due to this reason, it is hard to determine the shape of the long-run supply curve.
The shape of the long-run supply curve depends on the associated cost of production with the expansion of the market or entry and exit of firms. The long-run supply curve is the graph that helps us depict the information about the industry and the behavior of cost in that industry. There are three types of long-run supply curves, depending on the behavior of the cost of production in the industry.
- Types of industries depending on their long-run supply curves:1. Constant Cost Industry;2. Increasing Cost Industry;3. Decreasing Cost Industry.
The long run is a certain period when all of the costs and prices of factors of production fluctuate.
Now, Let's get straight into the constant cost industry.
We know that the entry of new firms affects the cost of production in the long run. However, there are certain instances where the entry of new firms does not affect the costs associated with the production of the overall industry. This type of industry is known as a constant cost industry. The industry's long-run supply curve is a flat horizontal line.
The perfectly competitive industry where the entry of new firms does not affect its overall cost of production is known as a constant cost industry.
Some of the examples of constant cost industry are:
1. Stationery Industry;
2. Internet Service Industry.
Causes of Constant Cost Industry
Now that we know a bit more about the constant cost industry, let us learn about the causes of the constant cost industry.
- The primary reason for the constant cost is that industry demand for the accompanying raw materials is much lower than the overall demand for these raw materials.
The constant cost industry is the industry where the cost of production does not change with the change in output of the overall industry. The major cause behind the constant cost is that the industry demand for the associated raw materials is significantly lower than the overall demand for these raw materials.
Constant Cost Industry Example
Now, let us look at an example of a constant-cost industry in a perfectly competitive market.
Let us suppose that Thomas owns the stationery industry and specializes in manufacturing notebooks. In the long run, the profit of the overall industry started to increase and many other manufacturers started to enter the industry. As the number of manufacturers increased, the demand for paper-producing wood also increased.
Other sectors, such as furniture and those that specialize in the construction of wooden buildings, have a higher demand for wood. However, as compared to other industries, the need for the amount of wood required to generate wood pulp in the paper-making business is substantially lower. As a result, even if the number of manufacturers increases, there is no price difference when Thomas purchases wood.
Therefore, as the price of wood does not increase, the cost of production for Thomas remains constant.
Constant Cost Industry Elasticity
Now let's dive deeper into the concept of elasticity in the constant cost industry.
Fig. 1 - Constant Cost Industry Elasticity
In Figure 1, the long-run supply curve is denoted as LRSC. In the long run, the supply curve in a constant cost industry is a flat horizontal line which depicts that a constant cost industry's supply curve is perfectly elastic.
Changes in the factors of production in the long-run
In the long run, numerous changes in production factors occur. Furthermore, many companies enter and exit the market, causing considerable fluctuations in industry supply. Since long-run production factors are varied, supply is more elastic in the long run than in the short run.
To learn more, don't forget to check out our articles on:- Long Run Supply Curve;- Short Run Supply Curve.
Constant Cost Industry Supply Curve
Now, Let us have a look at the graph of the constant cost industry in a perfectly competitive industry to understand how firms react to the changes in the industry.
Fig. 2 - Constant Cost Industry Supply Curve
We know that the long-run supply curve of the constant cost industry in a perfectly competitive market is horizontal from which we can deduce that the constant cost industry's supply curve is perfectly elastic. In Figure 2 above, the diagram on the left represents the output of a firm, whereas the diagram on the right represents the output of the overall industry.
Let us first assume that the entire industry is generating quantity Q1 for $P1. The demand for the product or service provided by the industry increases as a result of changing market conditions. The demand curve shifts from D1 to D2, causing the price to rise from $P1 to $P2. Because of the price increase, existing businesses attempt to improve profits by creating additional output. Following the increase in industry prices, the individual firm changes its output from Q1 to Q2. This profit will entice new firms to enter the market while existing ones will seek to expand their operations.
The supply curve shifts to the right from S1 to S2 as a result of new entrants into the market and increasing operations by existing firms. As the rise in industrial output does not affect input prices, new entry occurs until the initial price of $P1 is attained. This, ultimately, increases the quantity of production of the overall industry at the constant input price.
Constant Cost vs Increasing Cost Industry
Let's get into the concept of the increasing cost industry and learn how it differs from the constant cost industry.
- Constant Cost vs Increasing Cost Industry
| Constant Cost Industry | Increasing Cost Industry |
| 1. Horizontal long-run supply curve | 1. The upward-sloping long-run supply curve |
| 2. Production cost remains constant in the long run even if the industry expands. | 2. Production cost increases in the long run with the expansion of the industry. |
| 3. Perfectly elastic supply curve | 3. The supply curve is not perfectly elastic |
Fig. 3 - Constant Cost vs Increasing Cost Industry
Figure 3 above depicts a constant cost vs increasing cost industry in a perfectly competitive market. The manufacturing cost in the constant cost industry remains constant at P1 over a long time horizon. The price of a constant cost industry remains constant at $P1 over a long time horizon.
However, it is not the case in the increasing-cost industry. In an increasing-cost industry production costs rise over time as the market expands. Figure 3 shows that in the increasing-cost industry, the beginning cost of production is P1, but the cost has escalated to P3 in the long term. Figure 3 shows that in the increasing cost industry the price is initially at $P1, but it has escalated to $P3 in the long run. As a result, the supply curve of the increasing cost industry is sloping upward.
Fig. 4 - Increasing, Decreasing, and Constant Cost Industry.
Likewise, there is another type of perfectly competitive industry known as decreasing cost industry. In a decreasing-cost industry, production cost decreases in the long run. As a result, the supply curve of the decreasing cost industry is downward-sloping.
The perfectly competitive industry in which the manufacturing cost decreases with the expansion of the market, in the long run, is known as the decreasing cost industry.
The perfectly competitive industry in which the manufacturing cost increases with the expansion of the market, in the long run, is known as the increasing cost industry.
To gain comprehensive insights into the increasing cost industry,check out our article: Increasing Cost Industry!
Constant Cost Industry - Key Takeaways
- The industry where the entry of new firms does not affect its overall cost of production, in the long run, is known as a constant cost industry.
- The major cause behind the constant cost is that the industry demand for the associated raw materials is significantly lower than the overall demand for these raw materials.
- In the long run, the supply curve in a constant cost industry is a flat horizontal line which depicts that, a constant cost industry's supply curve is perfectly elastic.
- The long-run supply curve is more elastic than the short-run supply curve.
- The industry in which the manufacturing cost increases with the expansion of the market, in the long run, is known as the increasing cost industry.
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