The long period equilibrium of industry is different under different cost conditions. Price and cost adjustment depends upon whether the industry is operating under constant cost or increasing cost or decreasing cost conditions. It is explained below:
(a) Constant returns or constant cost industry:
Constant cost industry is that industry in which Average cost remains constant irrespective of increase or decrease in its output.
Firms in such an industry neither have external economics nor external economies. Long period equilibrium under constant cost industry is illustrated.
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DD is initial demand curve for an industry and SS is an initial supply curve of an industry. The demand curve DD and supply curve SS intersect each other at E, point.
Therefore, the industry is in equilibrium at E, point and OP price is determined. At this price every firm will be in equilibrium at ‘e’ point and will produce ON level of output. At OP price all firms will earn normal profits.
With the increase in demand for the product of the industry, the demand curve shifts upward to D1 D1. The demand curve D1 D1, cuts the supply curve SS at E2 point and thus price rises to OP1.
At this new price OP, the firm will begin to earn super-normal profits; the new firms will enter into the industry to increase supply.
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As a result of increase in supply, the supply curve shifts downward-right to S1,S1,. The new demand curve D1 D1, and new supply curve S1, S1, cut each other at E3 point.
Therefore, the short period price OP1, will fall to normal price OP and demand and supply will increase from OQ to OQ1, level.
We notice that there is no change in normal price OP because industry- operates under constant returns (constant cost conditions). If we join long period equilibrium points E, and E3, we get long period supply curve LS.
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(b) Diminishing returns or increasing cost industry:
Increasing cost industry is that industry in which average cost increases with expansion of output.
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In this type of industries external diseconomies exceed external economies of scale when output increases. Long period equilibrium in such type of industries is illustrated.
Initially the firms are in equilibrium at ‘e’ point and the industry is in equilibrium at E, point where demand curve DD and supply SS cut each other.
When the industry is in equilibrium at E, point, the equilibrium output is ON and equilibrium price is OP.
Now we suppose that due to increase in demand the demand curve shifts to D,D,. Demand curve D1 D1 cuts the supply curve SS at E2 point and the short period price rises to 0P2.
At increased price 0P2 the present firms of the industry begin to earn super-normal profits. Super-normal profits will attract new firms in the industry in the long period and this will increase output and average cost of production in the industry.
Since it is an increasing cost industry, with the entry of new firms the AC and MC curves of the firms will shift upward.
With the entry of new firms the supply of the commodity increases and supply curve shifts to S1, S1. Now short period supply curve cuts the demand curve D1 D1, at E3 point.
At the long period equilibrium point E3 the price is OP, and output is N1 Thus it is clear that due to increase in demand the long-period normal price is increased to OP1, and output is increased from ON to ON1,.
Long period supply curve is obtained by joining E and E3 points. Now firms equilibrium position has also changed to E1, point.
(c) Decreasing cost industry (increasing returns):
The long period supply curve of decreasing cost industry slopes negatively because external economies exceed external diseconomies.
Thus, when total output of the industry increases the AC and MC curves of firms shift downward. The determination of equilibrium output and price in the long period is explained.
Initially industry is in equilibrium at E, point where demand curve dd and supply curve SS intersect each other and equilibrium price is OP.
Initially the firms are in equilibrium at ‘e’ point. Suppose demand for the commodity increases and due to this demand curve shifts to d1,d1,
As a result of increase in demand the short-period price rises to P, because demand curve d1,d1, cuts the supply curve s1s1 at E2 point.
At this increased price OP, present firm starts getting super-normal profits. Due to super-normal profits new firms enter into the industry and consequently the supply curve shifts to s1, s1,.
Now supply curve s1, s1, cuts the demand curve d1,d1, at E3 point and price falls to OP2 level. Since it is a decreasing cost industry, the AC and MC curves of firms shift downward.
It is clear that the new long period equilibrium price OP2 is less than initial price OP. As a result of increase in demand the equilibrium output of the industry increases from Om to Om.
From the above discussion it is clear that long period normal price is affected by the cost-change in the long period.