Long-Run Competitive Equilibrium

We wish to understand why, in the last ten years, the price of personal computers has gone down and the quantity produced has increased.

Consider the following facts listed below. For purposes of this problem, simply take these facts as given and do not bring in/draw upon information not presented in this list of facts. [Throughout the problem, you may assume that the firm purchases inputs to production in perfectly competitive input markets, so each firm faces input supply schedules that are perfectly elastic (horizontal).]

Fact 1: The personal computer market is a perfectly competitive market. [This means that price = marginal cost = minimum average total cost in long-run equilibrium, and that there is free entry and exit. In the product market, the firm takes the price of personal computers as given (faces a horizontal demand curve.)]

Fact 2: Entry of new firms into the personal computer industry does not affect the price of inputs used by the industry. [This means that the personal computer industry is characterized as a constant-cost industry.]

Fact 3: Personal computers have become more popular in the last ten years. [In the market for personal computers, the industry demand curve has shifted out (demand has increased).]

Fact 4: The cost of production for computers has decreased due to technological innovations.

Suppose the personal computer market was in an initial long-run equilibrium ten years ago and is in a long-run equilibrium today. Use long-run equilibrium analysis to answer the following questions.

5.1: Can you explain the data (increase in production and decrease in prices) using the first three facts (Facts 1,2 and 3) mentioned above?

5.2: Can you explain the data based only on Facts 1,2 and 4 mentioned above

5.3: Answer the question posed in Question 5.2 above again, but instead of supposing the personal computer industry is a constant-cost industry, this time suppose the personal computer industry is a decreasing-cost industry.

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Solution Summary

A decreasing-cost industry is investigated here.