In industries with continuous technological improvement, low-cost plants will exist side by
side with older high-cost plants. The older plants will continue operating as long as their
revenues cover their variable costs.A second characteristic of a competitive industry subject to continuous
technological improvement is that price is eventually governed by the
minimum ATC of the lowest-cost (i.e., the newest) plants. New firms using
the latest technologies will enter the industry until their plants are just
expected to earn zero economic profits over their lifetimes. The benefits
of the new technology are passed on to consumers because all the units of
the product, whether produced by new or old plants, are sold at a price
that is related solely to the ATCs of the new plants. Owners of older
plants find that their returns over variable costs fall steadily as newer
plants drive the price of the product down.
A third characteristic is that old plants are discarded (or “mothballed”)
when the price falls below their AVCs. This may occur well before the
plants are physically worn out. In industries with continuous
technological progress, capital is usually discarded because it is
economically obsolete, not because it is physically worn out. Old capital is
obsolete when the market price of output does not cover its average
variable cost of production. Thus, a steel mill that is still fully capable of
producing top-quality steel may be shut down for perfectly sensible
reasons; if the price of steel cannot cover the average variable cost of the
steel produced, then profit-maximizing firms will shut down the plant.