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.

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 could 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 cost, cost 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 cost 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 of 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, 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 cost 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.

- [Announcer] 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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