Firms’ Choices in the Very Long Run
Firms respond to market signals that indicate changes in the economic
environment. For example, consider the situation faced by Dofasco—a
major steel producer located in Hamilton, Ontario—when the price of
coal (a major input) increases and is expected to remain at the higher
level for some time. How can Dofasco respond to this change in the
economic environment?
One option for Dofasco is to make a long-run response by substituting
away from the use of coal by changing its production techniques within
the confines of existing technology. This might involve switching to other
fuels (whose prices have not increased) to operate Dofasco’s enormous
blast furnaces. Another option is to invest in research in order to develop
new production techniques that innovate away from coal (and other fuels
as well), such as the design of blast furnaces that require less fuel to
process each unit of iron ore.
Faced with increases in the price of an input, firms may either substitute away or innovate away
from the input—or do both over different time horizons.It is important to recognize that these two options can involve quite
different actions and can ultimately have quite different implications for
productivity. For example, consider three different responses to an
increase in Canadian labour costs. One firm relocates its production