Production in the Short Run

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Presentation transcript:

Production in the Short Run

Short-run & Long-run Costs Short-run: the short-run is the time period in which at least one variable is fixed (i.e. cannot be varied or adjusted) Fixed plant capacity Variable intensity of plant use Variable output Long-run: the long run is the time period in which all inputs can be varied or adjusted Variable plant capacity Firms enter and exit

Fixed-Inputs: a fixed input is an input whose quantity is fixed and cannot be varied It is usually assumed that capital and land are fixed Variable Inputs: a variable input is an input whose quantity the firm can vary It is usually assumed that labor and raw materials are variable

Total, Average and Marginal Product Given a fixed plant capacity there are three key variables, Total Product (TP): is the total quantity of output produced with a given quantity of the variable input (e.g. labor) Average Product (AP): measures labor productivity, it represents the output per labor input. Marginal Product (MP): extra output associated with adding a unit of the variable resource (e.g. labor),

We must know how output changes as the amount of labor is changed Example; Suppose that there are only two inputs, labor (denoted L) and capital (denoted K). Labor is a variable input and capital is a fixed input Therefore, in the short run, output (q) can only be changed (increased or decreased) by changing (increasing or decreasing) labor We must know how output changes as the amount of labor is changed Capital (K) Sewing Machines 3 Labor (L) Workers per day 1 2 3 4 5 6 Total Product T-shirts per day 80 200 250 270 280 Marginal Product T-shirts per day 80 120 50 20 10 -10 Average Product T-shirts per day 80 100 83.3 67.5 56 46

Law of Diminishing Returns Law of Diminishing returns: as successive units of a variable resource (labor) are added to a fixed resource (capital or land) beyond some point the extra, or marginal, product that can be attributed to each additional unit of the variable resource will decline. The addition of more variable input causes marginal product to fall after some point

Three Stages of Production The above graph can be divided into three ranges: In the first range, MPL increases as more workers are added. The slope of the total product curve is getting steeper In the second range, MPL decreases as more workers are added The slope of the total product curve is positive but getting flatter In the third range, MPL falls below zero and total product decreases This range is never chosen by business.

Average versus Marginal Product There are three cases we need to examine, MPL > APL then APL is increasing & the slope of the AP curve is positive MPL = APL then APL is constant & the slope of the AP curve is zero MPL < APL then APL is decreasing & the slope of the AP curve is negative