(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 335

310 PART 2 • 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.