Increasing Cost Industry

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.

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.

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.

Fig. 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.

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.

Fig. 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 $P_2, 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:

Fig. 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.