Imagine that you are one of the few manufacturers of toys in a certain city. Due to the sudden growth of the child population, the demand for toys skyrockets, and you start earning supernormal profits. This causes other firms to enter the market, which increases your competition. Now the question is, will you continue to earn supernormal profits? The find out the answer, let's get straight into the long-run supply curve article!
Long Run Supply Curve Definition
Before directly jumping into the long-run supply curve definition, let's have a quick refresher on perfect competition. In perfect competition, the firms in the market are each other's direct competitors, sell identical products, and operate in a market with low entry and exit barriers.
- The characteristics of a firm in a perfectly competitive market are:1. Firms are price takers, which means that they don't have any power to influence the market price of a product or service.2. Firms sell products that are easily substitutable with the product of their competitors.3. There is a low barrier to entry and exit, which means any firm can enter and exit the market at its convenience.
A perfectly competitive market is one where firms are direct competitors of each other, sell identical products, and operate in a market with low entry and exit barriers.
Now, let us learn about the long-run supply curve.
We know the long run is a period where numerous firms can enter and exit the market. All of the firm's inputs, including the fixed ones, are variable in the long run. This causes fluctuations in the market price, which makes it hard to determine the shape of the long-run supply curve in a perfectly competitive market.
The long-run supply curve is a diagram that helps us comprehend the long-run price of a product or a service in a particular industry.
Want to learn comprehensively about the perfect competition, why not check out:- Perfectly Competitive Market;- Perfectly Competitive Firm.
The Long Run Supply Curve in Perfect Competition
Now, let us look at the long-run supply curve in perfect competition.
In a perfectly competitive market, there are three types of industries depending on the long-run supply curve.
The three types of industries are:
- Increasing cost industry;
- Decreasing cost industry;
- Constant cost industry.
Fig. 1 - The long-run supply curve in perfect competition
Long-run supply curves in a perfectly competitive market are determined by the industry's price. If the price rises as the industry expands, it is referred to as an increasing cost industry in a perfectly competitive market. Similarly, a constant cost industry is one in which the price remains constant during a long period of industry expansion. Finally, a decreasing-cost industry is one in which the price drops over time as the industry expands.
- The three types of industries in long run perfectly competitive market are:
- Increasing cost industry;
- Decreasing cost industry;
- Constant cost industry.
The Long Run Market Supply Curve
Now, let us understand the concept of the long-run market supply curve assuming an industry with a constant cost.
Fig. 2 - The long-run market supply curve
In Figure 2, the diagram on the left shows a firm's output, while the diagram on the right represents the output of the entire industry.
Initially, the overall market is in equilibrium at point A, with the price level at P1 and output at Q1. Because of changing market conditions, demand for the product rises, causing the demand curve D1 to move to the right to D2. As demand rises, firms in the industry raise their prices to P2. This change in the individual firms' prices causes the whole industry's price to rise from P1 to P2. The industry is now producing a Q2 quantity of output at the new equilibrium at point B.
Attracted by higher profit margins, other firms get an incentive to enter the market. As a result of the entry of new firms, the supply curve shifts from S1 to S2. Since an increase in industrial output does not affect input prices, new entry occurs until the initial price P1 is reached, forming a new equilibrium C. This raises the entire industry's output to Q3 at a constant input price (P1). Hence, LRSC is the long-run supply curve of an industry with a constant cost.
In the long run, the supply curve in a constant cost industry is a flat horizontal line, indicating that the supply curve in a constant cost industry is perfectly elastic.
You've come this far by learning! Great Job! Now, why not explore more in our another article:- Constant Cost Industry.
Long Run Supply Curve: Decreasing Cost Industry
Now, let's learn about the long-run supply curve in a decreasing-cost industry.
The industry in which the production cost decreases, in the long run, is known as decreasing cost industry. The slope of the decreasing-cost industry is downward-sloping. Let us look at the example to understand the concept clearly.
For example, Jack owns an automobile industry where the inputs can be acquired at a lower price as the volume of production increases. As there is a cost advantage in buying input parts of an automobile in bulk from a supplier, Jack, along with his competitors, buys the inputs (brakes, window glass, etc.) from suppliers that specialize in producing it efficiently. Hence, as the production volume increases, the average production cost of automobiles decreases.
The decreasing cost industry is defined as one in which the price of a product decreases in the long run.
Want to learn more about other types of long-run supply curve industries?
Do check out our articles on:- Constant Cost Industry;- Increasing Cost Industry.
Short Run vs Long Run Supply Curve
Now, let us look at the difference between the short-run and long-run supply curves.
In the short run, it is very tough for a company to cover all of its costs (variable and fixed costs) that are incurred during its operation. The company is not able to cover such a sum of money and make a business profitable in the short run. So, in the short run, the main motive of the company is to cover all of the variable expenses and continue to run the business until they become profitable in long run. So, we can say that a firm in the short run needs to adjust its variable costs to remain in business.
Now, let's see how the short-run supply curve of a firm compares to the long-run supply curve.
The decisions taken by a firm are very different in the short run and the long run. Unlike the short run, the long run is a period where many firms enter and exit the market and all of the firm's input acts as a variable cost (even the fixed costs). In the short run, the motive of a firm is to cover its variable cost with the earned revenue whereas, in the long run, a firm tries to make a substantial profit.
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