Question

Suppose that each of the following is true: (1) The laptop computer industry is perfectly competitive, and the firms that assemble laptops do not also make the displays or screens; (2) the laptop display industry is also perfectly competitive; and (3) because the demand for laptop displays is currently relatively small, firms in the laptop display industry have not been able to take advantage of all the economies of scale in laptop display production. Use a graph of the laptop computer market to illustrate the long-run effects on equilibrium price and quantity in the laptop computer market of a substantial and sustained increase in the demand for laptop computers. Use another graph to show the effect on the cost curves of a typical firm in the laptop computer industry. Briefly explain your graphs. Do your graphs indicate that the laptop computer industry is a constant-cost industry, an increasing-cost industry, or a decreasing-cost industry?

Short answer

The increase in demand for laptops leads to an increase in the equilibrium price and quantity. If significant economies of scale are achieved in the laptop displays industry, this will lower the average total cost for the laptop manufacturing firms, which indicates a decreasing-cost industry.

Step-by-step solution

Understanding Perfect Competition

In a perfectly competitive market, firms are price-takers, which means that they must accept the market price determined by the forces of demand and supply. The products are homogeneous, and there are many buyers and sellers.

Drawing the initial equilibrium

Draw a demand-supply graph for the laptop computer market before the increase in demand. Label the initial equilibrium price and quantity (P1, Q1). For the laptop manufacturing industry graph, draw the cost curves which include average total cost (ATC), marginal cost (MC), and average variable cost (AVC) curves.

Shift in Demand

Due to an increase in the demand for laptops, the demand curve will shift to the right. This leads to an increase in the equilibrium price and quantity (P2, Q2). This will increase the demand for laptop displays leading to potential economies of scale in the laptop display industry.

Changes in the Cost Curves

With the increase in demand, the laptop manufacturing firms will start to increase output, moving along the MC curve. If the laptop display industry achieves significant economies of scale, this will lower the costs of the laptop manufacturing firms, making the MC and ATC curves shift downward.

Identifying the Type of Industry

The type of the industry can be determined by observing the change in long-run average total cost (LRATC) curve. If LRATC remains constant as output increases, the industry is a constant-cost industry. If LRATC decreases as output increases, the industry is a decreasing-cost industry. If LRATC increases as output increases, the industry is an increasing-cost industry. In this case, if economies of scale are achieved, it indicates a decreasing-cost industry.

Key concepts

Equilibrium Price and Quantity

In a perfectly competitive market, the equilibrium price and quantity are determined by the intersection of the demand and supply curves.
At this point, the quantity of goods buyers want to buy equals the quantity sellers want to sell.
For the laptop computer market, this equilibrium was initially represented as

• Price: P1
• Quantity: Q1

When there is a substantial increase in demand, the demand curve shifts to the right. This shift causes an increase in both equilibrium price and quantity.
The new equilibrium is shown by:

• Price: P2
• Quantity: Q2

This movement represents a natural adjustment in the market. It can reflect how producers respond to an increase in demand by supplying more at a higher price.
This is a fundamental trait of a perfectly competitive market, where price changes efficiently signal the need to adjust quantity supplied.

Economies of Scale

Economies of scale occur when increasing production leads to a lower cost per unit.
Essentially, as firms produce more, they can spread their fixed costs over a larger number of units.
In the laptop display industry, firms were previously unable to fully exploit these economies of scale because the demand was too low.
However, with a consistent rise in demand for laptops, this changes.

• Larger production volumes make it possible for firms to optimize their manufacturing processes.
• They can negotiate better terms for bulk purchasing of inputs.
• Greater demand supports technological improvements that reduce costs.

These changes result in a decrease in the average costs. As a result, industries can enter a phase of more competitive pricing and potentially increased profits due to a larger volume of sales matched with lower production costs per unit.

Cost Curves

In the context of the laptop manufacturing industry, firms need to consider cost curves such as the average total cost (ATC) and marginal cost (MC).
These curves demonstrate how costs behave as production levels change.
Initially, costs were stable at a certain level of production.
However, when demand rises significantly, firms have the chance to produce more, and herein lies a possible shift in cost curves:

• Marginal Cost (MC): Reflects the addition to total cost by producing one more unit. With economies of scale, the MC curve may shift downward as more units are produced at a lower cost.
• Average Total Cost (ATC): Represents the total cost per unit, averaging fixed and variable costs. A downward shift in the ATC curve means producing additional units is cheaper.

This adjustment can lead to more efficient production processes that sustain competitiveness amidst rising demand.

Constant-Cost Industry

A constant-cost industry is one where the input prices and average costs remain stable as industry output expands.
This happens because inputs are abundantly available, and the industry is not large enough to significantly affect the supply and demand for those inputs.
In this scenario, the massive increase in demand for laptops may not lead to changes in the long-run average total cost (LRATC) if the industry achieves economies of scale consistently across increased production.
Here are characteristics of such an industry:

• Inputs needed for laptop production, such as screens and assembly labor, become effectively managed at scale without cost hike.
• Resource and technology use adapts to efficiently maintain costs.

A perfectly competitive market must continuously evaluate its cost structures to keep up with demand shifts without escalating costs, indicating a constant-cost framework if successful.
In this exercise, if the laptop display industry successfully achieves and maintains economies of scale, the laptop industry could be a constant-cost industry in the long run.