blanchard_ch10

000200010270728684ch10p195 220qxd 413 pm page 210

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Unformatted text preview: the case we have just studied—no external economies or diseconomies. The long-run market supply curve (LSA) is perfectly elastic. In this case, a permanent increase in demand from D0 to D1 has no effect on the price in the long run. The increase in demand brings a temporary increase in price to PS and in the short run the quantity increases from Q0 to QS. Entry increases shortrun supply from S0 to S1, which lowers the price from PS back to P0 and increases the quantity to Q1. Figure 10.11(b) shows the case of external diseconomies. The long-run market supply curve (LSB) slopes upward. A permanent increase in demand from D0 to D1 increases the price in both the short run and the long run. The increase in demand brings a temporary increase in price to PS and in the short run the quantity increases from Q0 to QS. Entry increases short-run supply from S0 to S2, which lowers the price from PS to P2 and increases the quantity to Q2. One source of external diseconomies is congestion. The airline market provides a good example. With bigger airline market output, congestion at both airports S1 S0 PS Price Long-Run Changes in Price and Quantity FIGURE 10.11 Price and in the air increases, resulting in longer delays and extra waiting time for passengers and airplanes. These external diseconomies mean that as the output of air transportation services increases (in the absence of technological advances), average cost increases. As a result, the long-run market supply curve is upward sloping. A permanent increase in demand brings an increase in quantity and a rise in the price. (Markets with external diseconomies might nonetheless have a falling price because technological advances shift the long-run supply curve downward.) Figure 10.11(c) shows the case of external economies. The long-run market supply curve (LSC ) slopes downward. A permanent increase in demand from D0 to D1 increases the price in the short run and lowers it in the long run. Again, the increase in demand brings a temporary increase in price to PS and in the short run the quantity increases from Q0 to QS. Entry increases short-run supply from S0 to S3, which lowers the price to P3 and increases the quantity to Q3. An example of external economies is the growth of spet support services for a market as it expands. Price 210 6/23/11 S0 S0 S2 PS PS S3 LSB P2 LSA P0 P0 P0 P3 D1 D1 D0 0 Q0 QS 0 Q1 Q0 QS D0 0 Q2 Q0 QS Quantity (b) Increasing-cost industry Three possible changes in price and quantity occur in the long run. When demand increases from D0 to D1, entry occurs and the market supply curve shifts rightward from S0 to S1. In part (a), the long-run market supply curve, LSA, is horizontal. The quantity increases from Q0 to Q1, and the price remains constant at P0. animation D1 D0 Quantity (a) Constant-cost industry LSC Q3 Quantity (c) Decreasing-cost industry In part (b), the long-run market supply curve is LSB; the price rises to P2, and the quantity increases to Q2. This case occurs in industries with external diseconomies. In part (c), the long-run market supply curve is LSC; the price falls to P3, and the quantity increases to Q3. This case occurs in a market with external economies. 000200010270728684_CH10_p195-220.qxd 6/23/11 4:13 PM Page 211 C hanging Tastes and Advancing Technology As farm output increased in the nineteenth and early twentieth centuries, the services available to farmers expanded. New firms specialized in the development and marketing of farm machinery and fertilizers. As a result, average farm costs decreased. Farms enjoyed the benefits of external economies. As a consequence, as the demand for farm products increased, the output increased but the price fell. Over the long term, the prices of many goods and services have fallen, not because of external economies but because of technological change. Let’s now study this influence on a competitive market. Technological Change Industries are constantly discovering lower-cost techniques of production. Most cost-saving production techniques cannot be implemented, however, without investing in new plant and equipment. As a consequence, it takes time for a technological advance to spread through a market. Some firms whose plants are on the verge of being replaced will be quick to adopt the new technology, while other firms whose plants have recently been replaced will continue to operate with an old technology until they can no longer cover their average variable cost. Once average variable cost cannot be covered, a firm will scrap even a relatively new plant (embodying an old technology) in favor of a plant with a new technology. New technology allows firms to produce at a lower cost. As a result, as firms adopt a new technology, their cost curves shift downward. With lower costs, firms are willing to supply a given quantity at a lower price or, equivalently, they are willing to supply a larger quantity at a given price. In other words, market supply increases, and the market supply curve shifts rightward. With a given demand, the quantity produced increases and the price...
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