Question

Explain what occurs in the long run in a constantcost industry, an increasing- cost industry, and a decreasing-cost industry when the market demand declines (shifts in).

Short answer

Question: Explain the impact of a decline in market demand on the market price, output level, and industry size for constant cost, increasing cost, and decreasing cost industries. Answer: In a constant cost industry, when market demand declines, the equilibrium price remains unchanged, and the output level and industry size decrease. In an increasing cost industry, a decreased market demand results in a lower equilibrium price and quantity, and the industry size reduces as some firms exit the market. In a decreasing cost industry, market demand decline leads to a decrease in the equilibrium quantity demanded but the market price remains unchanged, and the industry size may shrink while firms continue to operate at a lower cost per unit of production.

Step-by-step solution

Understand the Constant Cost Industry

In a constant cost industry, the costs of production do not change as the output increases or decreases. As a result, the supply curve of a constant cost industry appears horizontal, since the price does not increase with the increase in output.

Analyze the Market Demand Decline in a Constant Cost Industry

When the market demand declines in a constant cost industry, the overall quantity demanded decreases and the equilibrium price does not change. This is because the cost per unit of production remains constant and the supply is perfectly elastic at the initial market price.

Understand the Increasing Cost Industry

In an increasing cost industry, production costs increase as output increases and the supply curve is upward sloping. This industry experiences economies of scale up to a certain output level, after which further increase in output leads to increasing costs per unit of production.

Analyze the Market Demand Decline in an Increasing Cost Industry

When the market demand declines in an increasing cost industry, the demand curve shifts inwards, leading to a decrease in the equilibrium quantity and price. Some firms may exit the market as their costs become higher than the market price, resulting in a decrease in the total output and industry size.

Understand the Decreasing Cost Industry

In a decreasing cost industry, production costs decrease as output increases, and the supply curve is downward sloping. This industry experiences economies of scale throughout its production process, where an increase in output leads to a decrease in the average cost of production.

Analyze the Market Demand Decline in a Decreasing Cost Industry

When the market demand declines in a decreasing cost industry, the demand curve shifts inwards, leading to a decrease in the equilibrium quantity demanded. However, as the production costs decrease with the drop in market demand, the market price remains unchanged. The industry size may shrink due to the reduced demand, but the firms within the industry continue to operate at a lower cost per unit of production.