"Strong prices traditionally cause industries to expand, eventually bringing an end to high prices and the prosperity of firms." Does this statement makes sense? Explain in words and graphs.
I will be happy to critique your thinking on this.
The given statement is based on the principle of supply and demand in economics. Traditionally, when the prices of a particular product or service are high, it signals a strong demand and limited supply. This often leads to increased profitability for firms operating in that industry, as they can charge higher prices and generate higher revenues.
As a result of the high profits, firms are incentivized to enter the market, expanding their operations to take advantage of the lucrative conditions. This expansion of firms leads to an increase in the overall supply of the product or service in the market. When supply begins to exceed demand, prices tend to decrease due to increased competition among firms offering similar products or services.
To illustrate this concept, we can use a basic supply and demand graph. In this graph, the vertical axis represents the price, and the horizontal axis represents the quantity. The supply curve shows the relationship between the price and the quantity of a product or service that firms are willing and able to supply. The demand curve shows the relationship between the price and the quantity that consumers are willing and able to purchase.
Initially, when prices are high due to strong demand and limited supply, the supply curve would be relatively low, and the demand curve would be high, resulting in high prices. However, as firms expand to capitalize on the profitable conditions, the supply curve would shift to the right, indicating an increase in supply. When supply begins to exceed demand, the demand curve would shift downward as consumers are less willing to purchase at higher prices.
Eventually, as supply continues to increase and demand weakens, the new equilibrium point on the graph will have lower prices and a higher quantity supplied. This process of expansion and subsequent price decrease helps bring an end to high prices and reduce the profitability of firms, leading to a more balanced market where supply matches demand.
It is important to note that this process may not occur immediately or in a linear fashion. Market conditions, competition, and other factors can influence how quickly or slowly the industry expands and adjusts to changes in prices.