Constant Cost Industry

Causes of Constant Cost Industry

Now that we know a bit more about the constant cost industry, let us learn about the causes of the constant cost industry.

• The primary reason for the constant cost is that industry demand for the accompanying raw materials is much lower than the overall demand for these raw materials.

The constant cost industry is the industry where the cost of production does not change with the change in output of the overall industry. The major cause behind the constant cost is that the industry demand for the associated raw materials is significantly lower than the overall demand for these raw materials.

Constant Cost Industry Example

Now, let us look at an example of a constant-cost industry in a perfectly competitive market.

Constant Cost Industry Elasticity

Now let's dive deeper into the concept of elasticity in the constant cost industry.

Fig. 1 - Constant Cost Industry Elasticity

In Figure 1, the long-run supply curve is denoted as LRSC. In the long run, the supply curve in a constant cost industry is a flat horizontal line which depicts that a constant cost industry's supply curve is perfectly elastic.

Constant Cost Industry Supply Curve

Now, Let us have a look at the graph of the constant cost industry in a perfectly competitive industry to understand how firms react to the changes in the industry.

Fig. 2 - Constant Cost Industry Supply Curve

We know that the long-run supply curve of the constant cost industry in a perfectly competitive market is horizontal from which we can deduce that the constant cost industry's supply curve is perfectly elastic. In Figure 2 above, the diagram on the left represents the output of a firm, whereas the diagram on the right represents the output of the overall industry.

Let us first assume that the entire industry is generating quantity Q₁ for $P_1. The demand for the product or service provided by the industry increases as a result of changing market conditions. The demand curve shifts from D₁ to D₂, causing the price to rise from $P₁ to $P₂. Because of the price increase, existing businesses attempt to improve profits by creating additional output. Following the increase in industry prices, the individual firm changes its output from Q₁ to Q₂. This profit will entice new firms to enter the market while existing ones will seek to expand their operations.

The supply curve shifts to the right from S₁ to S₂ as a result of new entrants into the market and increasing operations by existing firms. As the rise in industrial output does not affect input prices, new entry occurs until the initial price of $P₁ is attained. This, ultimately, increases the quantity of production of the overall industry at the constant input price.

Constant Cost vs Increasing Cost Industry

Let's get into the concept of the increasing cost industry and learn how it differs from the constant cost industry.

• Constant Cost vs Increasing Cost Industry

  Constant Cost Industry	Increasing Cost Industry
  1. Horizontal long-run supply curve	1. The upward-sloping long-run supply curve
  2. Production cost remains constant in the long run even if the industry expands.	2. Production cost increases in the long run with the expansion of the industry.
  3. Perfectly elastic supply curve	3. The supply curve is not perfectly elastic

Fig. 3 - Constant Cost vs Increasing Cost Industry

Figure 3 above depicts a constant cost vs increasing cost industry in a perfectly competitive market. The manufacturing cost in the constant cost industry remains constant at P₁ over a long time horizon. The price of a constant cost industry remains constant at $P₁ over a long time horizon.

However, it is not the case in the increasing-cost industry. In an increasing-cost industry production costs rise over time as the market expands. Figure 3 shows that in the increasing-cost industry, the beginning cost of production is P₁, but the cost has escalated to P₃ in the long term. Figure 3 shows that in the increasing cost industry the price is initially at $P₁, but it has escalated to $P₃ in the long run. As a result, the supply curve of the increasing cost industry is sloping upward.

Fig. 4 - Increasing, Decreasing, and Constant Cost Industry.

Likewise, there is another type of perfectly competitive industry known as decreasing cost industry. In a decreasing-cost industry, production cost decreases in the long run. As a result, the supply curve of the decreasing cost industry is downward-sloping.