Question

If new technology in a perfectly competitive market brings about a substantial reduction in costs of production, how will this affect the market?

Short answer

In a perfectly competitive market, new technology that significantly reduces production costs will result in a rightward shift of the supply curve, a decrease in equilibrium price, and an increase in equilibrium quantity. Firms will produce more at the new lower costs, eventually passing the cost savings onto consumers in the form of lower prices.

Step-by-step solution

1. Characteristics of Perfectly Competitive Market

A perfectly competitive market is characterized by the following features: 1. Large number of buyers and sellers, each with a small market share 2. Homogeneous products, meaning all firms produce identical products 3. Free entry and exit, allowing firms to enter and exit the market without significant barriers 4. Perfect information, where both buyers and sellers have complete knowledge about prices and products 5. No externalities or government intervention

2. Impact of Reduced Production Costs on Market

When new technology leads to a substantial reduction in production costs, it affects the supply curve, market equilibrium, and firm behavior in the following ways: a. Shift in Supply Curve: The reduced costs of production cause the supply curve to shift to the right. This occurs because firms are now able to produce the same output at a lower cost, which means they are willing to supply more of the product at the same price level. b. Change in Market Equilibrium: With the shift in supply curve, the market equilibrium changes as well. The increased supply leads to a decrease in equilibrium price and an increase in equilibrium quantity (assuming demand remains constant). c. Adjustments by Firms: In a perfectly competitive market, firms are price takers and maximize their profits by producing at a level where marginal cost equals marginal revenue. The reduced costs encourage firms to produce more, and since the market is perfectly competitive, there will be a tendency towards the long-run equilibrium where price equals the minimum average total costs. As a result, the lower costs will likely be passed on to consumers in the form of lower prices.

3. Summary and Conclusion

In a perfectly competitive market, the introduction of new technology that substantially reduces production costs will likely lead to: 1. A shift in the supply curve to the right as firms can produce the same output at a lower cost. 2. A decrease in the equilibrium price and an increase in equilibrium quantity as a result of the shift in supply. 3. Adjustments by firms to produce more quantity at the new lower costs, resulting in lower prices being passed on to consumers. Overall, the market will experience lower prices and increased production as firms take advantage of lower costs and seek to maximize their profits in the perfectly competitive market.