Question

Exercise 1: Perfect competition and technology

Consider a perfectly competitive market that is currently in a short-run equilibrium, and where each firm in the market is making strictly positive profits. Each firm in the market is using a technology called the type A technology. Suppose that the type A technology is available in some finite number. Passed some threshold, new firms that would enter the market would have to use the type B technology, a different (and inferior) technology. The type B technology results in a higher long run average total cost curve than the type A technology. Given that the market exhibits positive profits in this short run equilibrium, new firms are going to enter the market. Claim: In the long run equilibrium, all firms in the market will be making zero economic profits. As usual, the use of graphs, whenever appropriate, is encouraged.

Answer 1

Ans. =

Currently, Firms are having Abnormal Profits in the Short Run.

Attracted by Abnormal Profits, new firms will start entering the industry.

Increase in number of firms and Hence, Quantity of Industry Output Increases.

Industry Supply Rises (As shown in the left graph of Industry - S1 shifts to S2) , which leads to fall in the prices.

Decrease in Level of Abnormal Profits of the firm that used to be there in the beginning.

Finally, the process will end at the point of Equilibrium where the firm earns only Normal Profits (at point K in the Right Graph, This is the point of Equilibrium for the firms where firms earn only Normal Profits).

At point of Equilibrium, K :

Price = Minimum LAC (Long Run Average Cost) = Minimum SAC (Short Run Average Cost) = LMC (Long Run Marginal Cost) = SMC (Short Run Marginal Cost)

_______________________________________

Please UPVOTE if you find this Answer Helpful and Post your Doubts (if any) in the comment section.

Thanks

_______________________________________