Question

1. Now suppose that a new technology were created that lowers the costs of production, graphically illustrate and explain the changes that arise in the short-run and long-run within a perfectly competitive industry.

Please show all the work with the steps, please.

Answer 1

LONG RUN

Industries may experience reductions in input prices as they expand with the entry of new firms. That may occur because firms supplying the industry experience economies of scale as they increase production, thus driving input prices down. Expansion may also induce technological changes that lower input costs. That is clearly the case of the computer industry, which has enjoyed falling input costs as it has expanded. An industry in which production costs fall as firms enter in the long run is a decreasing-cost industry.

Just as industries may expand with the entry of new firms, they may contract with the exit of existing firms. In a constant-cost industry, an exit will not affect the input prices of the remaining firms. In an increasing-cost industry, the exit will reduce the input prices of remaining firms. And, in a decreasing-cost industry, input prices may rise with the exit of existing firms.

A reduction in production cost shifts the firm’s cost curves down. The firm’s average total cost and marginal cost curves shift down, as shown in Panel (b). In Panel (a) the supply curve shifts from S₁ to S₂. The industry supply curve is made up of the marginal cost curves of individual firms; because each of them has shifted downward by $3, the industry supply curve shifts downward by $3. An increase in variable costs would shift the average total, average variable, and marginal cost curves upward. It would shift the industry supply curve upward by the same amount. The result in the short run would be an increase in price but by less than the increase in cost per unit. Firms would experience economic losses, causing exit in the long run. Eventually, the price would increase by the full amount of the increase in production cost.