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310 PART • Producers, Consumers, and Competitive Markets E XA MPLE 8.6 CONSTANT-, INCREASING-, AND DECREASING-COST INDUSTRIES: COFFEE, OIL, AND AUTOMOBILES As you have progressed through this book, you have been introduced to industries that have constant, increasing, and decreasing long-run costs Let’s look back at some of these industries, beginning with one that has constant long-run costs In Example 2.7, we saw that the supply of coffee is extremely elastic in the long run (see Figure 2.18c) The reason is that land for growing coffee is widely available and the costs of planting and caring for trees remains constant as the volume of coffee produced grows Thus, coffee is a constant-cost industry Now consider the case of an increasing-cost industry We explained in Example 2.9 that the oil industry is an increasing cost industry with an upwardsloping long-run supply curve (see Figure 2.23b) Why are costs increasing? Because there is a limited availability of easily accessible, large-volume oil fields Consequently, as oil companies increase output, they are forced to obtain oil from increasingly expensive fields Finally, a decreasing-cost industry We discussed the demand for automobiles in Examples 3.1 and 3.3, but what about supply? In the automobile industry, certain cost advantages arise because inputs can be acquired more cheaply as the volume of production increases Indeed, the major automobile manufacturers—such as General Motors, Toyota, Ford, and Honda—acquire batteries, engines, brake systems, and other key inputs from firms that specialize in producing those inputs efficiently As a result, the average cost of automobile production decreases as the volume of production increases The Effects of a Tax In Chapter 7, we saw that a tax on one of a firm’s inputs (in the form of an effluent fee) creates an incentive for the firm to change the way it uses inputs in its production process Now we consider ways in which a firm responds to a tax on its output To simplify the analysis, assume that the firm uses a fixed-proportions production technology If it’s a polluter, the output tax might encourage the firm to reduce its output, and therefore its effluent, or it might be imposed merely to raise revenue First, suppose the output tax is imposed only on this firm and thus does not affect the market price of the product We will see that the tax on output encourages the firm to reduce its output Figure 8.18 shows the relevant short-run cost curves for a firm enjoying positive economic profit by producing an output of q1 and selling its product at the market price P1 Because the tax is assessed for every unit of output, it raises the firm’s marginal cost curve from MC1 to MC2 ϭ MC1 ϩ t, where t is the tax per unit of the firm’s output The tax also raises the average variable cost curve by the amount t The output tax can have two possible effects If the firm can still earn a positive or zero economic profit after the imposition of the tax, it will maximize its profit by choosing an output level at which marginal cost plus the tax is equal to the price of the product Its output falls from q1 to q2, and the implicit effect of the tax is to shift its supply curve upward (by the amount of the tax) If the firm can no longer earn an economic profit after the tax has been imposed, it will choose to exit the market Now suppose that every firm in the industry is taxed and so has increasing marginal costs Because each firm reduces its output at the current market price, the total output supplied by the industry will also fall, causing the price of the product to increase Figure 8.19 illustrates this An upward shift in the supply curve, from S1 to S2ϭ S1 ϩ t, causes the market price of the product to increase (by less than the amount of the tax) from P1 to P2 This increase in price diminishes some of the effects that we described previously Firms will reduce their output less than they would without a price increase
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