Question

Show graphically and explain how an increase in the technology that augments the fixed factor of production of perfectly competitive firms affects the price, output and profits of a representative firm in both the short-run and in the long-run.

Answer 1

Consider the given problem here in the SR case the initial price level is “P1” and the optimum quantity supplied is “q1”, => the level of profit earned by the individual firm is given by, “P1A1A2B1”.

Now, as the technology improve, => the “SRATC” and the “SRMC” will shift downward to “SRATC2” and “SRMC2”. So, the new equilibrium is “A0”, => the optimum quantity supplied increases to “q2 > q1” and the level of profit also increases to “P1A0B2B3”. Now, if all the firms into the industry experience this technological advantage, => all the firm will increase its output, => the industry supply curve will shift to right, => the “P” decreases to “P2 < P1”, => the optimum profit maximizing output is given by “q3<q2” and the level profit is “P2CB5B4”.

So, in the SR as a result of the technological improvement “q” and profit of the both firm increases compare to the initial situation and the “P” decreases.

Now, consider the case of the LR situation.

So, here the initial “ATC” and “MC” are given by “LRATC “ and “LRMTC1”, => the LR equilibrium is given by “A1”, => the output supplied by all firms are given by “q1” and the price is “P1”.

Now, technological innovation leads to decrease in “LRATC” and “LRMTC” to “LRATC2” and “LRMTC2” respectively, => at the old price “P1” firm increase output to “q2” leads to positive economic profit, => new firm will enter into the industry, => the “P” starts decreasing, => the new equilibrium will established at “A2”, => the output supplied by the individual firm decrease to “q1”, => and the profit come to the normal profit.

So, as the effect of technological innovation “q” and profit remain same but the “P” decreases.