The Increasing Cost Case
The entry of new firms may cause the average cost of all firms to rise for several reasons. Entry of new firms may increase the demand for scarce inputs, driving up their prices. New firms may impose external costs on existing firms (and on themselves) in the form of air or water pollution, and new firms may place strains on public facilities (roads, courts, schools, and so forth), and these may show up as increased costs for all firms.
Figure 10-8 demonstrates market equilibrium for this increasing cost case. The initial equilibrium price is P1. At this price. The typical firm in Figure 10-8(a) produces q1 and total output, shown in Figure 10-8(c), is Q1. Suppose that the demand curve for this product shifts outward to D’ and the short-run supply curve (S) intersect at P2. At this price, the typical firm produces q2 and earn a substantial profit. This profit attracts new entrants into market and shifts the short-run supply curve outward.