Decreasing-Cost Industries

Definition

Decreasing-cost industries are those where the average cost of production decreases as the quantity of output increases. This phenomenon is often observed in industries with significant economies of scale, where larger production volumes lead to lower per-unit costs due to the efficient utilization of resources and the ability to spread fixed costs over a greater number of units.

5 Must Know Facts For Your Next Test

1. Decreasing-cost industries often exhibit a downward-sloping long-run average cost (LRAC) curve, indicating that as output increases, the average cost of production decreases.
2. The presence of significant fixed costs and the ability to spread these costs over a larger number of units are key drivers of decreasing-cost industries.
3. In decreasing-cost industries, new firms can enter the market and existing firms can expand their production, leading to increased competition and a potential decrease in market price.
4. The long-run equilibrium in a decreasing-cost industry is characterized by a price equal to the minimum point on the LRAC curve, with firms earning normal profits.
5. Technological advancements, learning effects, and the ability to leverage large-scale production methods are common factors that contribute to the decreasing-cost nature of an industry.

Review Questions

• Explain how the concept of economies of scale relates to decreasing-cost industries.
  • Economies of scale are a key driver of decreasing-cost industries. As firms in these industries increase their scale of production, they can take advantage of cost-saving measures such as more efficient utilization of resources, the ability to spread fixed costs over a larger number of units, and the implementation of advanced production technologies. This allows these firms to produce each additional unit at a lower average cost, resulting in a downward-sloping long-run average cost curve and the decreasing-cost industry phenomenon.
• Describe how the entry and exit of firms in a decreasing-cost industry can impact the market equilibrium.
  • In a decreasing-cost industry, the entry of new firms or the expansion of existing firms can lead to an increase in total industry output. This increased supply can put downward pressure on the market price, potentially driving it towards the minimum point on the long-run average cost curve. As a result, the long-run equilibrium in a decreasing-cost industry is characterized by a price equal to the minimum point on the LRAC curve, with firms earning normal profits. The ability of firms to enter and exit the market freely can help maintain this long-run equilibrium.
• Analyze how technological advancements and learning effects can contribute to the decreasing-cost nature of an industry.
  • Technological advancements and learning effects are significant factors that can contribute to the decreasing-cost nature of an industry. Technological innovations can improve production processes, increase efficiency, and enable the utilization of larger-scale production methods, all of which can lead to lower per-unit costs. Additionally, as firms in the industry gain more experience and knowledge through the learning-by-doing effect, they can optimize their production techniques, streamline their operations, and further reduce their average costs. These factors, combined with the ability to spread fixed costs over a larger number of units, are key drivers of the decreasing-cost industry phenomenon.

Related terms

Economies of Scale:

Economies of scale refer to the cost advantages that businesses obtain due to their scale of operation, with larger businesses able to produce goods more efficiently than smaller ones.

Marginal Cost:

Marginal cost is the additional cost incurred by a business to produce one more unit of output.

Long-Run Equilibrium:

Long-run equilibrium is the state where a firm's output and price are stable, and the firm is making normal profits in the long run.