Entry, Exit, and Supply Curves: Decreasing Costs

In this video, we talk about the special case of the decreasing cost industry. As output increases, costs will continue to fall, and more firms will enter which, again, increases output. It’s a virtuous circle!
At the end of this video, we review the major points made in this section. If you find that something doesn’t quite make sense, feel free to re-watch videos as many times as you’d like.
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- [Alex] Today we're
going to wrap up

our discussion
of entry, exit and supply curves

by talking briefly
about the fascinating case

of the decreasing cost industry.

What's important and interesting
about decreasing cost industries is

that we think
that they explain clusters.

If you look around the world, you'll
see places like Dalton, Georgia,

known as the "Carpet Capital
of the World,"

because about 90%
of the world's manufactured carpet is

made in this one
small town in Georgia.

Or think about Silicon Valley
for computer technology

or Hollywood for movies.

Or how about Hangji, China
where they make three

to four billion toothbrushes a year
in this one small town.

Now what is it about Hangji, China?

Is there something special
which makes this town

just the ideal place in all
the world to make toothbrushes?

No, not at all.

It's not like mining
diamonds or gold.

Toothbrushes can be
made anywhere.

Is there anything really
special about Dalton, Georgia

which makes it the ideal place
for making carpets?

No, so why then do we see
these industrial clusters?

The idea is this: clusters evolve
when greater output decreases

local industry costs,
and the best way to explain this

is to give kind
of a stylized history which

fits the facts for many
of these clusters,

such as the one in Dalton, Georgia.

The idea is that the first firm locates
more or less randomly.

However, the first firm creates
some local knowledge.

In the case of Dalton, Georgia,

it was knowledge
about how to produce carpets.

It began to train workers
in specialized techniques

in order to produce carpets.

Some input suppliers
for the backing of the carpet,

for example, also began
to locate in Dalton, Georgia.

So there were advantages
which began to develop

in Dalton, Georgia simply
because one firm was there already.

A second firm looking
around the country

and deciding where to locate
then chooses to locate

in Dalton, Georgia
next to the first firm, because

that's where the specialized
inputs already exist.

That's where there's
some workers -- which already

understand the technology --
can be more easily found.

Once the second firm does that,

it contributes
to the local knowledge.

And the third firm looking around
also now finds that costs are

even lower in Dalton, Georgia
than they are elsewhere,

and the process continues.

You can think about this
as a virtuous circle.

Output increases
with the first firm.

That produces some decreases
in costs; costs fall.

That increases entry
as other firms come into that area

to take advantage
of those lower costs.

And that increases output,
and the process continues.

Of course, the process doesn't
continue forever.

We don't find costs going to zero,
but the process can continue

long enough so that Dalton, Georgia
gets an overwhelming advantage.

So many firms locate
in Dalton, Georgia producing carpets

that it would be crazy to produce
carpets anywhere else,

because Dalton, Georgia is where
you can easily find the workers,

where you can easily find
the knowledge,

where the suppliers
understand the business.

In Dalton, Georgia,
even the community colleges teach

the techniques needed
in order to produce carpet.

So these virtuous circles can
generate decreasing costs.

Okay, I'm not going
to say anymore about that.

I'm going to leave it
briefly for today.

If you do want to learn more,
I've provided a bonus lecture,

which is from MRUniversity,
on international trade,

particularly on trade
and external economies of scale.

I talk much more about
these clusters and their influence

on trade in that video,
which you'll also find

in your course materials.

Okay, let's sum up.

So in this chapter,
we've really done two things.

First, based upon profit
maximization in a firm's cost curves,

we've shown how a firm decides
how much to produce

and also when to enter
or exit an industry.

Second, based upon those
production decisions, we've shown

how a supply curve is built up
founded upon the choices of firms

in entering and exiting
and how much to produce.

And we've looked
at three particular cases,

the constant cost industry with
examples of domain name registration,

or spoons, or waiters, or rutabagas
has a flat supply curve.

Costs don't change as output
of the industry changes,

and so the supply curve is flat.

The increasing cost industry --
oil, steel, nuclear physicists --

costs increase -- industry
cost increases as output increases --

and as a result,
the supply curve increases.

And finally the uncommon
but important case of a decreasing

cost industry where at least
over some range,

and in a particular location, costs
can fall with increased quantity,

and how this type of cost
structure generates clusters,

clusters like Dalton, Georgia,
like Silicon Valley,

and Hollywood, and so forth

Okay, that's it. Thank you.

- [Narrator] If you want to test
yourself, click, "Practice Questions."

Or if you're ready to move on,
just click, "Next Video."

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