In Modules 3 and 4 we explained how consumers and businesses are better able to adjust purchases and production when they have more time. We are now going to explore this distinction between the short run and long run, and in particular what it means for the businesses’ ability to vary the size of their operation and facility.
- Think about several different types of industries or markets and the amount of time it might take to change the scale of operation and the size of the production facility for each of these examples. The long-run is a period of time long enough so that all inputs, including facility and equipment, are variable, while in the short run at least one input is fixed. Think about how much time it would take to change the scale of operation for a restaurant, for an automobile plant, for a website designing company… Does it seem that the amount of time that separates the long run from the short run is industry-specific, rather than a set period of time? Share three specific examples.
- Describe in detail how Diminishing Marginal Product arises from the assumption that some of a business’s inputs are in fixed quantity over the period of time that is the short run. Often the convention is to assume that the business’s production facility and the capital stock within it are the fixed factors of production in the short run. Inputs such as labor, and possibly some other supplies, are often assumed to be easier to adjust and therefore “variable” in the short run. The long-run then is whatever period of time is necessary for the firm to be able to vary all inputs. It may be helpful to use an example in your explanation of Diminishing Marginal Product.
- How would you represent the cost associated with the factors of production that cannot be varied in the short run? The total cost associated with these fixed inputs is referred to as Total Fixed Cost and mathematically is similar to a constant in the short run. Using the fact that Average Fixed Cost equals Total Fixed Cost divided by the quantity of output, explain how incurring a large fixed or “sunk” cost can be justified if a large amount of output is sold. Provide some examples of businesses and what might be some of their fixed costs. What would graphs of Total Fixed Cost and Average Fixed Cost as a function of output look like?