Normal Price and Law of Returns

• Normal price in the long run is the price at which a firm earns normal profit and price equals both average cost (AC) and marginal cost (MC).
• Normal price is strongly affected by the law of returns because these laws decide whether long-run costs fall, rise, or remain constant as output changes.
• Therefore, when demand changes, the effect on normal price depends on whether the industry is:

• • An increasing returns (decreasing cost) industry

  • A diminishing returns (increasing cost) industry

  • A constant returns (constant cost) industry

Meaning

• Under the law of increasing returns, when output is increased in the long run, the industry enjoys economies of scale (better technology, bulk buying, specialisation, etc.).
• As a result, average cost (AC) and marginal cost (MC) fall as output expands; this is why it is also called the law of diminishing costs.
• In long-run equilibrium, normal price = AC = MC, so when costs fall, the normal price also tends to fall.

Shape of supply curve and diagram idea

• The long-run supply curve SS slopes downward, showing that when more is produced, the cost per unit and hence the normal price fall.
• The initial demand curve DD intersects SS at point E, giving:
  Equilibrium price = OP
  Equilibrium output = ON
• When demand increases to D₁D₁, it intersects the same downward-sloping SS at E₁.
  New output rises beyond ON
  New equilibrium price falls to OP₁

Result
In an increasing returns (decreasing cost) industry, normal price falls when demand increases and rises when demand decreases.

Simple example
A large factory producing electronics may reduce per-unit cost as production expands due to better machines and bulk purchase of inputs; when more consumers want its product, higher output comes with lower cost per unit, allowing a lower normal price.

Meaning

• Under the law of diminishing returns, as output increases, the industry faces diseconomies of scale (management difficulties, overuse of fixed resources, higher input prices, etc.).
• This makes AC and MC rise when production is expanded, so it is also called the law of increasing costs.
• In the long run, price must cover these higher costs, so normal price rises when costs rise.

Shape of supply curve and diagram idea (Fig. 11)

• The long-run supply curve SS slopes upward from left to right, showing that higher output comes with higher cost and hence higher price.
• Initially, demand curve DD intersects SS at point E, giving:
  Equilibrium price = OP
  Output = OQ
• When demand increases to D₁D₁, the new equilibrium is at E₁ on the same upward-sloping SS.
  Output increases to OQ₁
  Equilibrium price rises to OP₁

Result
In a diminishing returns (increasing cost) industry, normal price rises when demand increases and falls when demand decreases.

Simple example
In agriculture, if more and more output is produced on the same land, after some point productivity per unit of input falls, costs per unit rise, and a higher long-run price is needed when demand is stronger.

Meaning

• Under constant returns, when output increases or decreases in the long run, AC and MC remain unchanged.
• There are neither strong economies nor strong diseconomies of scale; cost per unit stays roughly constant over the relevant range of output.
• Therefore, changes in output do not affect the normal price in the long run.

Shape of supply curve and diagram idea 

• The long-run supply curve SS is horizontal (parallel to the X-axis), showing that the industry can supply any quantity at the same normal price.
• The initial demand curve DD intersects SS at point E, giving:
  Equilibrium price = OP
  Output = OX
• When demand increases to D₁D₁, the new equilibrium is at E₁ on the same horizontal SS.
  Output increases to OX
  Price remains OP

Result
In a constant returns (constant cost) industry, normal price remains the same even if demand rises or falls; only the equilibrium quantity changes.

Simple example
In some perfectly competitive service industries where inputs are easily available at constant prices, firms can expand output without changing cost per unit, so the long-run normal price stays constant.

• The normal price in the long run is determined where price = AC = MC and firms earn normal profits.
• The effect of a change in demand on long-run normal price depends on the cost condition of the industry.
• Increasing returns (decreasing cost):
  The long-run supply curve slopes downward.
  When demand increases, normal price falls, quantity increases.
• Diminishing returns (increasing cost):
  The long-run supply curve slopes upward.
  When demand increases, normal price rises, and the quantity increases.
• Constant returns (constant cost):
  The long-run supply curve is horizontal.
  When demand increases, normal price remains unchanged; only the quantity increases.
• Thus, with an increase in demand, the long-run normal price may rise, fall, or remain constant, depending on whether the industry is increasing cost, constant cost, or decreasing cost.