The intense competition from gateway nec dell and

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Unformatted text preview: lowered the price and eliminated the economic profit. So IBM now concentrates on servers and other parts of the computer market. IBM exited the PC market because it was incurring economic losses. Its exit decreased market supply and made it possible for the remaining firms in the market to make zero economic profit. Long-Run Equilibrium You’ve now seen how economic profit induces entry, which in turn eliminates the profit. You’ve also seen how economic loss induces exit, which in turn eliminates the loss. When economic profit and economic loss have been eliminated and entry and exit have stopped, a competitive market is in long-run equilibrium. You’ve seen how a competitive market adjusts toward its long-run equilibrium. But a competitive market is rarely in a state of long-run equilibrium. Instead, it is constantly and restlessly evolving toward long-run equilibrium. The reason is that the market is constantly bombarded with events that change the constraints that firms face. 207 International Harvester, a manufacturer of farm equipment, provides another example of exit. For decades, people associated the name “International Harvester” with tractors, combines, and other farm machines. But International Harvester wasn’t the only maker of farm equipment. The market became intensely competitive, and the firm began to incur economic losses. Now the firm has a new name, Navistar International, and it doesn’t make tractors any more. After years of economic losses and shrinking revenues, it got out of the farm-machine business in 1985 and started to make trucks. International Harvester exited because it was incurring an economic loss. Its exit decreased supply and made it possible for the remaining firms in the market to break even. Markets are constantly adjusting to keep up with changes in tastes, which change demand, and changes in technology, which change costs. In the next sections, we’re going to see how a competitive market reacts to changing tastes and technology and how it guides resources to their highest-valued use. REVIEW QUIZ 1 2 What triggers entry in a competitive market? Describe the process that ends further entry. What triggers exit in a competitive market? Describe the process that ends further exit. You can work these questions in Study Plan 10.4 and get instant feedback. 000200010270728684_CH10_p195-220.qxd 208 6/23/11 4:13 PM Page 208 CHAPTER 10 Perfect Competition x Changing Tastes and Advancing Technology Increased awareness of the health hazards of smoking has decreased the demand for tobacco products. The development of inexpensive automobile and air transportation during the 1990s decreased the demand for long-distance trains and buses. Solidstate electronics has decreased the demand for TV and radio repair. The development of good-quality inexpensive clothing has decreased the demand for sewing machines. What happens in a competitive market when there is a permanent decrease in the demand for its product? Microwave food preparation has increased the demand for paper, glass, and plastic cooking utensils and for plastic wrap. The Internet has increased the demand for personal computers and the widespread use of computers has increased the demand for highspeed connections and music downloads. What happens in a competitive market when the demand for its output increases? Advances in technology are constantly lowering the costs of production. New biotechnologies have dramatically lowered the costs of producing many food and pharmaceutical products. New electronic technologies have lowered the cost of producing just about every good and service. What happens in a competitive market for a good when technological change lowers its production costs? Let’s use the theory of perfect competition to answer these questions. A Permanent Change in Demand Figure 10.10(a) shows a competitive market that initially is in long-run equilibrium. The demand curve is D0, the supply curve is S0, the market price is P0, and market output is Q0. Figure 10.10(b) shows a single firm in this initial long-run equilibrium. The firm produces q0 and makes zero economic profit. Now suppose that demand decreases and the demand curve shifts leftward to D1, as shown in Fig. 10.10(a). The market price falls to P1, and the quantity supplied by the market decreases from Q0 to Q1 as the market moves down along its short-run supply curve S0. Figure 10.10(b) shows the situation facing a firm. The market price is now below the firm’s minimum average total cost, so the firm incurs an eco- nomic loss. But to minimize its loss, the firm adjusts its output to keep marginal cost equal to price. At a price of P1, each firm produces an output of q1. The market is now in short-run equilibrium but not long-run equilibrium. It is in short-run equilibrium because each firm is maximizing profit; it is not in long-run equilibrium because each firm is incurring an economic loss—its average total cost exceeds the price. The economic loss is a signal for some firms to exit the market. As they do so, short-run mar...
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This note was uploaded on 01/10/2013 for the course ECON 251 taught by Professor Blanchard during the Spring '08 term at Purdue University.

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