Download Deriving the Long-Run Market Supply Curve

Deriving the Long-Run Market Supply Curve
The long-run supply (LS) curve gives information about the size of an industry and the
nature of costs in that industry.
Costs in industries are characterized by increasing, constant, or decreasing costs,
depending on the behavior of long-run costs as firms enter the industry in response to
increased demand.
To understand how to derive a market supply
curve, consider first an industry where there is
long-run equilibrium at price P0 and market
quantity of ye. There is no incentive for any
firm to change its behavior. Each firm is
covering its opportunity costs but no firm is
making economic profit.
The market on the left is such an industry.
Now consider an increase in demand in this
industry. If demand shifts from D to D’, there
will be an increase in price and an increase in
quantity supplied in the far left graph. In
response to short-run profits, new firms start
entering the market and the short-run
supply (SS) curve starts shifting to the right.
It is possible that in this the industry, as new
firms enter and SS shifts to the right, the longrun costs for all firms in the industry rise. The
rise in costs is attributable to firms bidding for
a scarce resource. For example, if this were
the trucking industry, qualified drivers may be
in short supply and firms would have to bid up
the wages to attract them. An industry such as
this is called an increasing cost industry.
In an increasing cost industry, the market
price rises to P1 at the intersection of the new
demand curve and the new short-run supply
curve. By connecting the old and new
equilibrium points, you derive the long-run
supply (LS) curve.
As on the left, the long-run supply curve (LS)
has a positive slope, reflecting the increasing
costs.
Another type of industry is one in which long
run costs remain constant as market demand
and supply change. This industry is a
constant cost industry and is depicted on
the left.
The LS curve has zero slope at the original
market price, reflecting the industry’s constant
costs.
A final example is on the left. It is the
decreasing cost industry.
As new firms enter and begin production,
costs for all firms in the industry may actually
decrease. The LRAC shifts down, a new
market price is established, and the derived LS
curve is down sloping.
The chart on the left summarizes the longrun supply market (LS) curves for
increasing, constant, and decreasing cost
industries.