Production in the short run is all about how firms manage their resources to create goods or services. It's like cooking in a kitchen with limited space and equipment. You've got to make the most of what you have while dealing with the constraints.
The key is understanding how different inputs affect output. As you add more workers or materials, you'll see changes in productivity. But there's a catch - at some point, adding more won't help as much. It's all about finding that sweet spot for maximum efficiency.
Production in the Short Run
Components of production functions
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- Represents relationship between inputs (resources used to produce goods or services) and outputs (final goods or services produced) in production process
- In short run, at least one input is fixed (factory size, machinery) while others are variable (labor, raw materials)
- Can be expressed as
- quantity of output
- fixed input (capital)
- variable input (labor)
Fixed vs variable inputs
- Fixed inputs are production factors that cannot be changed in short run
- Land, buildings, machinery
- Quantity remains constant regardless of output level
- Variable inputs are production factors that can be changed in short run
- Labor, raw materials, energy
- Quantity can be adjusted based on desired output level
- In short run, firm can only change output by adjusting quantity of variable inputs while fixed inputs remain constant
Changes in product measures
- Total product (TP) total quantity of output produced with given set of inputs
- As variable inputs increase, TP initially increases at increasing rate, then at decreasing rate, and eventually decreases
- Marginal product (MP) change in TP resulting from one-unit increase in variable input, holding other inputs constant
- MP initially increases as more variable inputs added, reaches maximum, then decreases
- Average product (AP) is the total product divided by the number of units of the variable input used
- Relationship between TP and MP divided into three stages:
- MP increases, TP increases at increasing rate
- MP decreases but remains positive, TP increases at decreasing rate
- MP becomes negative, TP decreases
Law of diminishing marginal returns
- States that as more units of variable input added to fixed input, marginal product of variable input will eventually decrease
- Applies in short run when at least one input is fixed
- As more variable inputs (labor) added to fixed input (capital), marginal product of variable input will initially increase but eventually decrease
- Leads to three stages of production:
- Increasing marginal returns
- Diminishing marginal returns
- Negative marginal returns
- Firms aim to produce in Stage 2, where MP decreasing but still positive, to maximize output and profit
Short-run vs long-run production decisions
- Short-run production decisions involve changing quantity of variable inputs while fixed inputs remain constant
- Firms adjust variable inputs to optimize output and profit given constraints of fixed inputs
- Long-run production decisions involve changing all inputs, as no fixed inputs in long run
- Firms can adjust scale of production by changing quantities of all inputs
- In short run, firms face diminishing marginal returns due to fixed inputs, limiting ability to increase output
- In long run, firms can change all inputs to achieve most efficient combination of resources and avoid diminishing marginal returns
- Long-run production decisions allow firms to achieve economies of scale by increasing scale of production and lowering average costs
Production Concepts and Efficiency
- Isoquants are curves that show different combinations of inputs that produce the same level of output
- Returns to scale describe how output changes as all inputs are increased proportionally in the long run
- Production possibilities frontier represents the maximum combination of goods that can be produced given available resources and technology
- Technological progress shifts the production possibilities frontier outward, allowing for increased production capabilities
Key Terms to Review (20)
Economies of Scale: Economies of scale refer to the cost advantages that businesses can exploit by expanding their scale of production. As a company increases its output, its average costs per unit typically decrease due to more efficient utilization of resources, specialized equipment, and division of labor.
Technological Progress: Technological progress refers to the advancement and improvement of technology over time, leading to increased efficiency, productivity, and innovation in various aspects of society and the economy. It encompasses the development of new tools, machines, processes, and techniques that enhance human capabilities and transform the way we live, work, and interact with the world around us.
Production Possibilities Frontier: The production possibilities frontier (PPF) is a model that represents the maximum output combinations of two different goods or services that an economy can produce given the available resources and technology. It illustrates the trade-offs and opportunity costs faced by an economy when allocating its limited resources between the production of different goods.
Short Run: The short run is a period of time in which at least one factor of production, typically capital, is fixed while other factors, such as labor, can be varied. This concept is central to understanding production and costs in the context of microeconomic analysis.
Labor: Labor refers to the human effort, both physical and mental, that is used in the production of goods and services. It is one of the primary factors of production, along with land, capital, and entrepreneurship, that contribute to the creation of economic value.
Capital: Capital refers to the resources, both physical and financial, that are used in the production of goods and services. It is a key factor of production, along with land, labor, and entrepreneurship, that enables economic activity and the generation of wealth.
Variable Input: A variable input is a factor of production that can be adjusted in the short run to increase or decrease the level of output. It is a resource that a firm can change the quantity of in order to impact its production process and the amount it can produce.
Average Product: The average product is a measure of productivity that represents the output per unit of input in the production process. It is calculated by dividing the total output by the quantity of the variable input used to produce that output.
Negative Marginal Returns: Negative marginal returns refers to the phenomenon where adding more of an input to a production process leads to a decrease in the additional output generated. This concept is particularly relevant in the context of production in the short run, where at some point, the addition of more variable inputs like labor will result in diminishing and eventually negative returns to production.
Production Function: The production function is a mathematical relationship that describes the maximum output that can be produced given a certain combination of inputs, such as labor, capital, and other resources. It is a fundamental concept in microeconomics that is crucial for understanding how firms make decisions about production in both the short run and the long run.
Marginal Product: Marginal product refers to the additional output or production that results from employing one more unit of a variable input, such as labor, while holding all other inputs constant. It represents the incremental change in total output as a result of using an additional unit of a particular input.
Law of Diminishing Marginal Returns: The law of diminishing marginal returns states that as more of a variable input (such as labor) is added to a fixed input (such as capital), the marginal product of the variable input will eventually decrease, even as the total product continues to increase.
Inputs: Inputs refer to the resources and factors of production used in the process of creating goods or services. These are the essential elements that go into the production process and determine the quantity and quality of the output.
Returns to Scale: Returns to scale refers to the behavior of output as a firm increases all of its inputs by the same proportion. It describes how a proportional change in all inputs leads to a change in output, and it is an important concept in the analysis of production and costs in both the short run and long run.
Diminishing Marginal Returns: Diminishing marginal returns is an economic principle that states as additional inputs are added to a production process, the marginal (incremental) output of that process will eventually decrease. This means that each additional unit of input (such as labor or capital) will yield a smaller increase in output compared to the previous unit.
Total Product: Total product is the total quantity of output produced by a firm or an economy using a given set of inputs over a specific period of time. It represents the total amount of goods or services generated through the production process and is a fundamental concept in the analysis of production in the short run.
Outputs: Outputs refer to the goods and services produced by a firm or an economy during a given time period. Outputs are the end result of the production process, which transforms inputs such as labor, capital, and raw materials into final products that can be sold and consumed.
Isoquant: An isoquant is a curve in a production function diagram that shows all the combinations of inputs that produce the same level of output. It represents the different ways a firm can combine inputs to achieve a given level of production.
Fixed Input: A fixed input is a factor of production that cannot be changed in the short run, such as the size of a factory or the number of machines. It is a key concept in understanding production in the short run, as it determines the constraints and limitations faced by a firm in adjusting its output levels.
Increasing Marginal Returns: Increasing marginal returns refers to the phenomenon where each additional unit of input (such as labor or capital) used in production leads to a greater increase in output than the previous unit. This concept is closely tied to the law of diminishing marginal returns, as it describes the opposite scenario where the marginal product of an input rises rather than falls as more of that input is utilized.