How do firms choose a technology?
Of course they first look at the
available technologies and choose the
one that costs
the least and produce the same quality
products.
As before, let's assume we're a textile
firm and we want to produce 100 meters of
cloth, and we want to work out the cost of
technology P1 for our firm.
This technology is relatively energy-intensive
because it requires three tons
of coal
and two workers. Now, how do we calculate the cost of this?
It all depends on two pieces of
information: the cost of labor for us and
the cost of coal.
Let's assume the cost of labor is £10 per hour -
the wage is £10 per hour, and the cost of coal is £20 per ton.
Now, given this
information, let's calculate the total
cost of technology P1. We're going to require two workers, so
two multiplied by £10 per hour.
Then we're going to need three tons of
coal so three multiplied
by £20. Overall we get £80
for the total cost of technology P1.
So, let's assume there's another
available technology for our firm,
P2, and this is a relatively
labor-intensive technology because
you're going to need
six workers and only one ton of coal to
produce 100 meters of cloth. Now let's
work out the cost of this technology.
You're going to be needing six workers,
so
that is six multiplied by £10 per
hour, and you're going to need only one
ton of gold - that's one multiplied by
£20, and then you still get £80,
the total cost of this technology.
Now that P1 and P2 cost the same we can actually draw a line between them, and
call this an isocost line. Whatever exists on
this line, costs the same for our firm and that is
£80, so our firm would be indifferent between
choosing P2 or P1 or any other technology that
may exist on this line. Now technology Q1 and Q2 lie
at a higher iso cost curve. There are
more costly
technologies obviously, why? Because, for
instance, if you compare
Q1 to P1, Q1 uses more of the both inputs - more worker and
more coal, so therefore it's definitely
more costly. Same with the Q2 - if you
compare Q2 with P1.
Now you might ask: what about technology Q3 here?
Yes, this technology is using less coal
but much much more workers, so the total cost of this technology
is still higher than P1 and P2.
Let's add more isocost lines. This line
is under £420, this one is $40.
As you can see anything to the right of
this
line costs more than £80, anything
on the left
costs less than that, so as a firm we
would like to
choose technologies that are at the
lowest
isocost curves. For instance, in this case £40,
however, we don't have any technologies
there,
those technologies have not been
invented yet, the available technologies
that are cheapest are P1
and P2. Now, let me add one final thing.
The slope of these curves
are the same, and that is the price of
labor over the price of coal, that is
wage £10 over the price of coal
£20 per ton, that is one over two.
We express it in minus terms because the
slope of the curves is
downward - this slope means that to use
one extra ton of coal our firm needs to
give up two of its workers in order to
keep the total cost of its production
the same. Let me give you an example.
Let's assume our firm is now producing a
technology F.
It's using 12 workers and no energy.
Now it wants to move to technology G. It
has to consume one extra ton of coal
but for that it needs to give up two of
its workers in order to keep the total cost of its
production the same.
Thank you.