Increasing Cost Industry

Assume you own a petrochemical production plant, and demand for your petroleum product dramatically increases. What would you do in such a scenario? You will most likely boost your output to enhance your profits! Based on your profits, several other companies will be encouraged to begin petroleum production. Will they, however, be able to make a comparable profit? Or, with their presence, will you be able to earn your existing profit? Turns out, the answer will depend on whether this is a constant, decreasing, or increasing cost industry. To find out more, let's get straight into the article!

Increasing Cost Industry Increasing Cost Industry

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Table of contents

    Long Run Supply Curve and Increasing Cost Industry

    Let's go over the long-run supply curve before diving into the increasing cost industry. In the long run, many firms enter and exit the market. As firms sell or buy their machinery, land, and other fixed assets, all of the firm's inputs become variable in the long run. This causes price fluctuations in the market, making it hard to determine the shape of the long-run supply curve. The long-run supply curve depends on the type of industry.

    • Types of industries depending on their long-run supply curves:
      1. Increasing Cost Industry;
      2. Decreasing Cost Industry;
      3. Constant Cost Industry.

    Want to learn about the long-run supply curve in detail?Then check out our article: Long Run Supply Curve!

    Definition of Increasing Cost Industry

    Let's get straight into the definition of the increasing cost industry!

    We know that the cost of production is affected by the increased production of existing businesses or by the entry of new ones. In the long run, the cost of production either increases or decreases depending on the industry. The industry in which the cost of production increases with the expansion of the market is known as the increasing cost industry. The supply curve of the increasing cost industry is upward-sloping.

    The increasing cost industry refers to the industry in which production costs rise as the market expands.

    Examples of an increasing cost industry are:

    1. Petrochemical industries;

    2. Coal mining industries.

    Causes of Increasing Costs in an Increasing-Cost Industry

    Now that we've learned a bit about the increasing-cost industry let's look at the causes of the increasing cost in an increasing-cost industry.

    • The fundamental reason for the increased cost in increasing cost industry is that industry demand for raw materials accounts for a substantial portion of overall raw materials demand.

    The increasing cost industry is where the cost of production increases with the change in output of the overall industry. The primary reason for the increasing cost of raw materials in the industry is that industrial demand accounts for a significant share of total raw material demand.

    Increasing Cost Industry Supply Curve

    Now, let us look at the graphical representation of the increasing cost industry and learn how firms react to changes in the overall industry.

    Increasing Cost Industry Increasing Cost Industry Supply Curve StudySmarteFig. 1 - Increasing Cost Industry Supply Curve

    Figure 1 depicts the concept of the long-run supply curve in an industry with increasing costs. The equilibrium is initially at point A, where the industry produces Q1 quantity, which is then sold at $P1. Due to changing market conditions, demand shifts from D1 to D2, increasing the product's price to $P2 and boosting industrial output to Q2.

    In reaction to industry changes, an individual firm shifts its output from q1 to q2. At this point, these firms start to make a higher amount of profit. Looking at those profits, new firms start to enter the industry. These new entries expand the industry and increase the demand for the inputs required for production. The supply curve subsequently shifts to S2, resulting in a new equilibrium B at the price of $P3, which is greater than the initial price of $P1.

    Now, in response to the overall industry, the average cost curve of individual firms shifts from AC1 to AC2, and the marginal cost curve shifts from MC1 to MC2. The firm's higher earnings are now eliminated since the price of $P3 equals the new average cost. As a result, equilibrium B is the new long-run supply curve in which the industry generates output Q3 at the input price P3.

    Increasing-Cost Industry Example

    Now, let us look at the comprehensive example of the increasing cost industry.

    Lets us assume that Jack owns a coal mining firm, and due to certain market conditions, the overall demand for coal increases. As a result of the increased demand, Jack starts selling a higher amount of output to earn extra profit.

    Now, as the industry started to earn higher profits, new firms entered the industry to get a share of those profits. With the entry of new firms, the amount of input required for production also increases. As the raw materials required for the production of coal are minimal, the cost of raw materials increases.

    Hence, as the coal mining industry's demand accounts for a significant portion of the overall market for required raw materials, the overall industry experiences increased costs.

    Constant Cost vs Increasing Cost Industry

    The long-run supply curve remains constant in certain industries despite changing market conditions. Let's look at the constant cost industry and learn how it differs from the increasing cost industry.

    Increasing Cost Industry Constant Cost vs Increasing Cost Industry StudySmarterFig. 2 - Constant Cost vs Increasing Cost Industry

    Figure 2 is the diagrammatical representation of the increasing and constant cost industries. In the increasing cost industry, initially, the equilibrium is at point A, where the industry is producing Q1 quantity that is sold at a price of $P1. As market conditions change, demand shifts from D1 to D2, raising the product's price to $P2 and increasing industrial output to Q2. At this point, the existing firms start to make heavy profits which entices new firms to enter the industry. These new entrants increase the demand for inputs, shifting the supply curve from S1 to S2, forming a new equilibrium at a price of $P3, which is higher than the price of $P1.

    However, in the case of the constant cost industry, the initial equilibrium is at point X, where the industry is producing a Q1 quantity that is sold for $P1. With the changing market conditions, the demand for the product increases, which shifts the demand curve from D1 to D2. The industries then start producing output in Q2 for $P2. Again, as the existing firms start making more profit, new firms enter the industry. As a result of industry expansion, the supply curve shifts from S1 to S2. The new entries occur until the initial price of $P1 is attained, as industrial output does not affect input prices in the constant cost industry.

    Therefore, the major difference between the increasing-cost industry and the constant-cost industry is that, in the increasing-cost industry, the rise in industrial expansion affects the input prices, whereas in the constant-cost industry, the expansion of industry does not affect the input prices.

    A constant cost industry is a perfectly competitive long-run industry in which the entry of new firms does not affect the cost of production of the overall industry in the long run.

    To learn more about the constant cost industry, check out our article: Constant Cost Industry.

    Increasing Cost Industry vs Decreasing Cost Industry

    In certain industries, the cost of production decreases with the industry expansion. Let's have a look at decreasing cost industry and how it differs from the increasing cost industry.

    Increasing Cost Industry Increasing Cost Industry vs Decreasing Cost Industry StudySmarterFig. 3 - Increasing Cost Industry vs Decreasing Cost Industry

    When the demand for an overall industry increases, there is an expansion of the industrial output. In both graphs in Figure 3, the initial equilibrium is for $P1. Further, with the increased demand, firms increase their output to Q2 for $P2, which enables them to earn more profit. Looking at that profit, new firms enter the industry. Now, this is the point where there is a major difference between the increasing cost industry and decreasing cost industry.

    As new firms enter the industry, the industry shifts to a new equilibrium at B, where the input price is $P3. In the case of the increasing cost industry, due to the limited input materials, the price of input after expansion ($P3) remains above the initial input price ($P1). However, in the decreasing-cost industry, due to the ample amount of inputs, the price of input after expansion ($P3) remains below the initial input price ($P1).

    The major differences between the decreasing cost industry and the increasing cost industry are:

    Decreasing Cost IndustryIncreasing Cost Industry
    1. The downward-sloping long-run supply curve.1. The upward-sloping long-run supply curve.
    2. Production cost decreases in the long run.2. Production cost increases in the long run.

    Increasing Cost Industry Increasing Cost Industry vs Decreasing Cost Industry StudySmarterFig. 4 - Increasing, Decreasing, and Constant Cost Industries.

    Figure 4 above illustrates the increasing, decreasing, and constant cost industries. We can see that all three perfectly competitive industries are different, depending on the behavior of cost. Therefore, the long-run cost increases in the increasing cost industry, decreases in the decreasing cost industry, and remains the same in the constant cost industry.

    Increasing Cost Industry - Key Takeaways

    • The industry in which the cost of production increases with the expansion of the market is known as the increasing cost industry.
    • The supply curve of the increasing cost industry is upward-sloping.
    • The fundamental reason for the increased cost in the increasing cost industry is that industry demand for raw materials accounts for a substantial portion of overall raw materials demand.
    • A constant cost industry is one in which the entry of new firms does not affect the cost of production of the overall industry in the long run.
    Frequently Asked Questions about Increasing Cost Industry

    What happens to price in an increasing-cost industry?

    The price (cost of production) increases in an increasing-cost industry as a result of industry expansion.

    What is the difference between increasing and decreasing cost industries?

    In the decreasing-cost industry the production cost decreases in the long run, whereas in the increasing-cost industry the production cost increases in the long run. 

    What causes an increasing cost in the industry?

    The major cost for the increased cost in the increasing cost industry is that industry demand for raw materials accounts for a substantial portion of the overall raw materials demand.

    What do you mean by increasing cost?

    Increasing cost refers to the increased cost of production in an industry at a certain time.

    Which long-run supply curve represents an increasing cost industry?

    The upward-sloping long-run supply curve represents an increasing cost industry.

    Can a firm in an increasing-cost industry have increasing returns to scale?

    Yes, a firm in an increasing-cost industry can have increasing returns to scale by focusing on increasing its efficiency with the existing raw materials.

    What is the key difference between a constant-cost industry and an increasing-cost industry?

    The key difference between the increasing cost industry and the constant cost industry is that in the increasing cost industry the rise in industrial expansion affects the input prices, whereas in the constant cost industry the expansion does not affect the input price.

    Test your knowledge with multiple choice flashcards

    The supply curve of the increasing cost industry is __________. 

    In an increasing-cost industry, the rise in industrial expansion affects the input prices.

    Decreasing cost industry has a downward-sloping supply curve.

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