Short Run and Long Run

A2 Markets & Market Systems Short Run and hanker Run Production As part of our introduction to the theory of the firm, we first consider the nature of yield of different goods and services in the forgetful and long get. The concept of a payoff government agencyThe outturn function is a mathematical expression which relates the metre of mover excitants to the quantity of takingss that result. We make use of three measures of production / productivity. * Total product is simply the total turnout that is generated from the factors of production busy by a channel enterprise.In close to manufacturing industries such as motor vehicles, freezers and DVD players, it is straightforward to measure the volume of production from force back and chapiter inputs that ar used. But in many service or knowledge-based industries, where much of the output is intangible or perhaps weight little we find it harder to measure productivity * Average product is the total output separate by the number of social units of the variable factor of production employed (e. g. utput per worker employed or output per unit of capital employed) * Marginal product is the depart in total product when an checkitional unit of the variable factor of production is employed. For illustration borderline product would measure the change in output that comes from increasing the employment of c get offch by one person, or by adding one more car to the production process in the short run. The Short Run Production FunctionThe short run is outlined in economics as a period of time where at least one factor of production is assumed to be in fixed supply i. e. it cannot be changed.We normally assume that the quantity of capital inputs (e. g. plant and machinery) is fixed and that production can be altered by suppliers through ever-changing the demand for variable inputs such as labour, components, raw materials and energy inputs. Often the amount of land purchasable for production is al so fixed. The time periods used in textbook economics are somewhat capricious because they differ from industry to industry. The short run for the electricity generation industry or the telecommunications sector varies from that steal for unsandedspaper and magazine publishing and small- outdo production of foodstuffs and beverages.Much depends on the time scale that permits a line to alter all of the inputs that it can bring to production. In the short run, the law of diminishing returns states that as we add more units of a variable input (i. e. labour or raw materials) to fixed amounts of land and capital, the change in total output will at first rise and and so wane. Diminishing returns to labour supervenes when marginal product of labour starts to fall. This core that total output will still be emergent but increasing at a decreasing rate as more workers are employed.As we shall discriminate in the following numerical example, eventually a decline in marginal product leads to a fall in average product. What happens to marginal product is linked directly to the productivity of each wasted worker employed. At low levels of labour input, the fixed factors of production land and capital, tend to be under-utilised which means that each additional worker will render plenty of capital to use and, as a result, marginal product may rise.Beyond a certain point however, the fixed factors of production become scarcer and new workers will not have as much capital to work with so that the capital input becomes diluted among a larger workforce. As a result, the marginal productivity of each worker tends to fall this is known as the principle of diminishing returns. An example of the concept of diminishing returns is shown below. We assume that there is a fixed supply of capital (e. g. 20 units) available in the production process to which extra units of labour are added from one person through to eleven. Initially the marginal product of labour is rising. * It peaks when the sixth worked is employed when the marginal product is 29. * Marginal product then starts to fall. Total output is still increasing as we add more labour, but at a slower rate. At this point the short run production demonstrates diminishing returns. The fairness of Diminishing Returns Capital Input Labour Input Total take Marginal Product Average Product of Labour 20 1 5 5 20 2 16 11 8 20 3 30 14 10 20 4 56 26 14 20 5 85 28 17 20 6 114 29 19 20 7 140 26 20 0 8 160 20 20 20 9 171 11 19 20 10 one hundred eighty 9 18 20 11 187 7 17 Average product will happen to rise as long as the marginal product is greater than the average for example when the ordinal worker is added the marginal gain in output is 26 and this drags the average up from 19 to 20 units. Once marginal product is below the average as it is with the ninth worker employed (where marginal product is only 11) then the average will decline. This marginal-average relationship is important to understa nding the nature of short run cost curves.It is worth going through this again to make sure that you understand it. Criticisms of the Law of Diminishing ReturnsHow realistic is this notion of diminishing returns? Surely ambitious and successful businesses do what they can to vitiate such a problem emerging. It is now widely recognised that the effects of globalisation, and in particular the skill of trans-national corporations to source their factor inputs from more than one country and engage in rapid transfers of business engineering and other information, makes the concept of diminishing returns less relevant in the real world of business.You may have read about the expansion of out-sourcing as a means for a business to cut their cost and make their production processes as flexible as possible. In many industries as a business expands, it is more likely to experience increasing returns. After all, why should a multinational business pop off huge sums on expensive research and development and investment in capital machinery if a business cannot extract increasing returns and lower unit costs of production from these extra inputs? Long run production returns to scaleIn the long run, all factors of production are variable.How the output of a business responds to a change in factor inputs is called returns to scale. * Increasing returns to scale occur when the % change in output % change in inputs * lessen returns to scale occur when the % change in output % change in inputs * Constant returns to scale occur when the % change in output = % change in inputs * A numerical example of long run returns to scale Units of Capital Units of Labour Total widening % Change in Inputs % Change in Output Returns to Scale 20 150 3000 0 300 7500 100 150 Increasing 60 450 12000 50 60 Increasing 80 600 16000 33 33 Constant 100 750 18000 25 13 lessen In the example above, we outgrowth the inputs of capital and labour by the same proportion each time. We then compare the % change in output that comes from a given % change in inputs. * In our example when we double the factor inputs from (150L + 20K) to (300L + 40K) then the percentage change in output is 150% there are increasing returns to scale. In contrast, when the scale of production is changed from (600L + 80K0 to (750L + 100K) then the percentage change in output (13%) is less than the change in inputs (25%) implying a situation of decreasing returns to scale. As we shall see a later, the nature of the returns to scale affects the shape of a businesss long run average cost curve. The effect of an increase in labour productivity at all levels of employment Productivity may have been increase through the effects of technological change improved incentives better management or the effects of work-related formulation which boosts the skills of the employed labour force.