Short Run

1

Short Run

• Short run: The quantity of at least one input, (ie: factory size) is fixed and the quantities of the other inputs, (ie: Labour) can be varied.

(short run decisions are easily reversed: there is no time to go in and out of business)

Decision Time Frames

•The actions that a firm can take to influence the relationship between output and cost depend on the time frame.

2

Long Run• Long run: the quantities of all inputs can be

varied, nothing is fixed, (ie: plant size can vary.)

(long-run decisions are not easily reversed: new firms can enter and old firms can leave; that is, firms can go in and out of business)

Decision Time Frames• Firms make two kinds of decisions:

– Short Run decisions govern the day to day operations of the firm

– Long Run decisions involve longer term strategic planning

3

The Costs of Production: Short Run

• S.R. Production Function

–the relationship between quantity of inputs used to make a good and the quantity of output when some factors are fixed and some are variable

4

Total, Marginal, & Average Product

Labour

(workers per day)

Total Product

(sweaters per day)

a 0 0

b 1 4

c 2 10

d 3 13

e 4 15

f 5 16

Marginal Product

(sweaters per additional

worker)

………..4

………..6

………..3

………..2

………..1

Average Product

(sweaters per worker)

4.00

5.00

4.33

3.75

3.20

MP=MP=TP/TP/QQLL

AP=TP/QL

5

Total Product & Marginal Product

Labour (workers per day)

10

15

Ou

tpu

t (sw

eate

rs p

er

day

)

0 1 2 3 4 5

Labour (workers per day)

Ma

rgin

al p

rodu

ct(s

we

ate

rs p

er

da

y p

er w

orke

r)

13

2

4

6

3

0 1 2 3 4 5

54

TP

c

d

10

13

2 3

MP

3

2 3

• total product (TP) always increasing

•as TP , & MP , TP increases at a decreasing rate

6

Marginal Product

Law of diminishing returns

As a firm uses more of a variable input, with a given quantity of fixed inputs, the

marginal product of the variable input

eventually diminishes.

Similar to diminishing Marginal Utility for consumers.

7

The Relationship Between a Firm’s Output and Costs in the Short Run

To produce more output in the short run, the firm must employ more variable factor, for example, labour, which increases its costs. There are three types of costs:

Total CostsMarginal Cost Average Cost Per Unit Costs

8

1.)Total Costs:

Total Totalfixed variable Totalcost cost cost

Labour Output(workers (sweaters (TFC) (TVC) (TC)per day) per day) (dollars per day)

a 0 0

b 1 4

c 2 10

d 3 13

e 4 15

f 5 16

25

25

25

25

25

25

0

25

50

75

100

125

25

50

75

100

125

150

TC = TFC + TVC

9

TC

TVC

Total Costs

0 5 10 15Output (sweaters per day)

50

100

150

Cos

t (d

olla

rs p

er d

ay)

TFC

TC = TFC + TVC

10

aa 00 0 0

bb 11 4 4

cc 22 1010

dd 33 1313

ee 44 1515

ff 55 1616

2525

2525

2525

25 25

2525

2525

00

2525

5050

75 75

100100

125125

2525

5050

7575

100 100

125125

150150

Total TotalTotal Total fixed variablefixed variable Total Total cost costcost cost cost cost

Labour OutputLabour Output(workers (sweaters (workers (sweaters ((TFCTFC) () (TVCTVC)) ( (TCTC))per day) per day)per day) per day) (dollars per day) (dollars per day)

6.25

4.17

8.33

12.50

25.00

MarginalMarginalcostcost

((MCMC))

2.)Marginal Cost2.)Marginal Cost

MC =

TC

TO

MC =

TVC

Q

the in total cost that results from a one-unit in output.

11

a 0 0

b 1 4

c 2 10

d 3 13

e 4 15

f 5 16

25

25

25

25

25

25

0

25

50

75

100

125

25

50

75

100

125

150

Total Total fixed variable Total cost cost cost

Labour Output(workers (sweaters (TFC) (TVC) (TC)per day) per day)

3.)Average Cost3.)Average Cost

6.25

4.17

8.33

12.50

25.00

Marginalcost

(MC)

—

6.25

2.50

1.92

1.67

1.56

Avg.fixedcost

(AFC)

TFC/Q

Avg.variable

cost

(AVC) TVC/Q

—

6.25

5.00

5.77

6.77

7.81

Avg.totalcost

(ATC) TC/Q

—

12.50

7.50

7.69

8.33

9.38

(dollars per day)

AVC AFC ATC Q

TVC

Q

TFC

Q

TC

12

Marginal Cost and Average Costs

5 10 15Output (sweaters per day)

5

10

15

Co

st (

dol

lars

per

sw

eat

er)

AFC

AVC

ATC

ATC = AFC + AVC

MC

0

25

13

Marginal Cost and Average Costs

5 10 15Output (sweaters per day)

5

10

15

Co

st (

dol

lars

per

sw

eat

er)

MC

0

25MC at low outputs due to gains from specialization, MC eventually due to law of diminishing returns.

14

Relationship between MC & ATC

Whenever MC < ATC, ATC MC > ATC, ATC

MC crosses ATC at the minimumMC crosses ATC at the minimum ATC ATC

(capacity or minimum efficient scale)(capacity or minimum efficient scale)

MC crosses AVC at the min. pointMC crosses AVC at the min. point

15

Shifts in the Cost Curves

The position of a firm’s short-run

cost curves depends on two factors:• technology• prices of resources

16

Long Run Costs of Production

•In the long run, all factors of production are variable,

•nothing is fixed.

•In the long run, firms are looking for productive efficiency,

•producing a given quantity at as low a

per unit cost as possible. •assuming a constant state of technology •and constant resource/input prices.

17

The long run is the firm’s planning perspective while the short run is the firm’s operating perspective.

18

The Long-Run Average Cost Curve

• The long-run average cost curve shows the relationship between the lowest attainable average total cost and output

• It is therefore derived from the short-run average total cost curves.

• Each SRATC touches the LRATC at the level of output for which the quantity of the fixed factor is optimal and lies above the LRATC for all other levels of output.

19

Preferable Plant Size and theLong-Run Average Cost Curve

Output per Time Period

Ave

rag

e C

ost

(dol

lars

per

uni

t of

ou

tpu

t)

Output per Time Period

Ave

rag

e C

ost

(dol

lars

per

uni

t of

ou

tpu

t)

SAC1

SAC2

Q1

C2

C1

C3

C4

Q2

SAC3

Build plant 1 if expected outputat Q1.

Build plant 2 if expected outputat Q2.

SAC1

SAC2

SAC3

SAC4

SAC5

SAC6

SAC7

SAC8

LACenvelope

20

12.00

10.00

8.00

6.00

Long-Run Average Cost Curve

0 5 10 15 20 25 30

ATC1 ATC2 ATC3 ATC4

LRAC curveLeast-costplant is 1

18

Least-costplant is 2



24

•Once the plant size is chosen, the firm operates on the short-run cost curves that apply to that plant size.

21

Shape of LRACShape of LRAC & Returns to Scale & Returns to Scale

• Returns to scale are the increases in output Returns to scale are the increases in output that result from that result from increasing all inputs by the increasing all inputs by the same percentage.same percentage.

• There are 3 PossibilitiesThere are 3 Possibilities. .

1)1)Increasing Returns to Scale or Increasing Returns to Scale or Economies of Scale:Economies of Scale: 2) 2)Decreasing Decreasing Returns to Scale or Diseconomies of Returns to Scale or Diseconomies of Scale:Scale: 3) 3)Constant Returns to ScaleConstant Returns to Scale

22

Economies/Diseconomies of Scale

Economies of scale, Increasing Returns

% inputs is less than % output

Decreasing LAC

Constant returns to scale

% inputs is equal to % output

Horizontal LAC

Diseconomies of scale, Decreasing Returns

% inputs is more than % output

Increasing LAC

23

12.00

10.00

8.00

6.00

Long-Run Average Cost Curve

0 5 10 15 20 25 30

LRAC curve

1818 2424

Economies of scale Diseconomies of scale

MES

Minimum efficient scale: the smallest quantity of output at which LRATC reaches its lowest level.

24

What would cause LRATC to shift?

1) change in the state of technology

2) change in input prices

Question•What is the difference between diminishing returns (MP) and diminishing returns to scale?

25

Perfect Competition

• A market structure in which the decisions of individual buyers and sellers have no effect on market price

No one person in the market has any

Market Power: the ability to influence the price.

–the minimum efficient scale is small relative to the demand for a good or service.

26

Characteristics of a Perfectly Competitive Market Structure

1.)Large number of buyers and sellers • no one buyer or seller has power to influence

price• Both firms and buyers are “price takers”

2) Homogenous products• goods offered by various producers are largely

the same.

3) No barriers to entry or exit

4) Buyers and sellers have equal information

27

Demand, Price, and Revenue in Perfect Competition

D

Quantity (thousandsof sweaters per day)

Pric

e (d

olla

rs p

er s

wea

ter)

0 9 20

25

50

Sweater market

S

Marketdemandcurve

Quantity (sweaters per day)

Pric

e (d

olla

rs p

er s

wea

ter)

25

50

Sidney’s demandand marginal revenue

MR

Sidney’sdemandcurve

0 9 20

FIRMINDUSTRY

28

Demand, Price, and Revenue in Perfect Competition: Firm

Quantity sold (Q)

(sweaters per day)

Price

(P) (dollars per

sweater)

Total revenue

(TR = PxQ)

(dollars)

Marginalrevenue

(MR =TR/Q)

(dollars)

8

9

10

25

25

25

200

225

250

25

25

29

Economic Profit and Revenue: Firm

Marginal revenue (MR) is the change in revenue resulting from a one-unit increase in output sold.

For the firm, in perfect competition, since the price remains constant when the

quantity sold changes –Marginal revenue equals price.

marginal revenue curve is also the demand curve.

–Demand is perfectly elastic.

30



Pric

e (d

olla

rs p

er s

wea

ter)

25

50

Sidney’s demandand marginal revenue

MR=P


0 9 20

D


Pric

e (d

olla

rs p

er s

wea

ter)

0 9 20

25

50

Sweater market

S

Marketdemandcurve

Market Price = $25

INDUSTRY FIRM

31

A firmA firm will produce the level of output that maximizes economic profits given the constraints it faces.market constraints summarized by its revenue

schedules.technology & cost constraints summarized by its

product & cost curves.

(TC) cost Total - (TR) revenue Total ProfitEconomic

Firm Maximizes Profits: “Supply”

32

Profit Maximization Rule• Produce all those units of output that add

more to revenues than to costs.

• Produce more output until MR comes closest to being equal to MC without MC exceeding MR:

output

TR (MR) Revenue Marginal

output

TC (MC) Cost Marginal

MR MR MC MC

33

Total Revenue, Total Cost, & Economic Profit

Quantity(Q)

(sweaters/day)

Total Revenue

(TR) (dollars)

Total Cost(TC)

(dollars)

EconomicProfit

(TR - TC) (dollars)

Average Total Cost (ATC) (dollars)

Average Var. Cost (AVC) (dollars)

Marginal Cost

(MC) (dollars)

0123456789

10111213

0255075

100125150175200225250275300325

22456685

100114126141160183210245300360

-22-20-16-10

011243440424030

0-35

045.0033.0028.3325.0022.8021.0020.1420.0020.3321.0022.27

2527.69

023.0022.0031.5019.5018.4017.3317.0017.2517.8918.8920.2723.1726.00

023.0021.0019.0015.0014.0012.0015.0019.0023.0027.0035.0055.0060.00

025.0025.0025.0025.0025.0025.0025.0025.0025.0025.0025.0025.0025.00

Marginal Revenue

(MR) (dollars)

P=MR

FIRM

34

Profit-Maximizing Output


8 9 10

10

20

30

$’s.

Mar

gina

l rev

enue

and

mar

gina

l cos

t

MR25

0

MCProfit-maximizationPoint, MC=MR

MR > MC MC > MR

Market Price = $25

• Beyond MC=MR output, MC>MR, TC is increasing more than TR, and profits are decreasing.

• Between zero output and MC = MR output, MR > MC, TR is increasing more than TC, and profits are increasing.

FIRM

35

Economic profit

0Quantity (sweaters per day)

Pri

ce a

nd

co

st (

dol

lars

pe

r sw

eate

r)

15.00

20.33

25.00

Economic Profit

9 10

30.00

MR

MC ATC

At P = $25, ATC =$ 20.33Output = 9 unitsTR = $25 x 9 = $225TC = $20.33 x 9 =$183Profit = $225-$183=$42Profit = (P-ATC) x output

Market Price = $25

FIRMNote: In Perfect Competition, MR=AR

36



Pric

e (d

olla

rs p

er s

wea

ter)

25

50

Sidney’s demandand marginal revenue: firm

MR


0 9 20

D


Pric

e (d

olla

rs p

er s

wea

ter)

0 9 20

25

50

Sweater market: Industry

S

New marketdemandcurve

D

20MR

Sidney’snew demandcurve

20

Market Price = $20FIRMINDUSTRY

37

Total Revenue, Total Cost, and Economic Profit

Quantity(Q)

(sweaters/day)

Total Revenue

(TR) (dollars)

Total Cost(TC)

(dollars)

EconomicProfit

(TR - TC) (dollars)



Marginal Cost

(MC) (dollars)

0123456789

10111213

020406080

100120140160180200220240260

22456685

100114126141160183210245300360

045.0033.0028.3325.0022.8021.0020.1420.0020.3321.0022.27

2527.69

023.0022.0031.5019.5018.4017.3317.0017.2517.8918.8920.2723.1726.00

023.0021.0019.0015.0014.0012.0015.0019.0023.0027.0035.0055.0060.00

020.0020.0020.0020.0020.0020.0020.0020.0020.0020.0020.0020.0020.00

Marginal Revenue

(MR) (dollars)

New Price

-22-25-26-25-20-14

-6-10

-3-10-25-60

-100

FIRM

38Quantity (sweaters per day)

Pri

ce a

nd

co

st (

dol

lars

pe

r sw

eate

r)

1515..0000

25.0025.00

88 10 10

30.0030.00

MRMR

MCMC ATCATC

20.0020.00

Break-even Point, MR=MC=ATC

00

Short-Run Break-Even Price

Break-Even PriceP=$20; ATC=$20

TR = $20X8 units/day

= $160

TC = $20X8units/day

= $160

TR = TC

= 0 Economic Profits

Market Price = $20

FIRM

39

Short-Run Losses, & Shutdown Price

• What do you think?

– Would you continue to produce if you were incurring a loss?

– What if price fell to $19.00?

– What if price fell to $16.00 or lower?

FIRM

40

Demand, Price & Revenue: Perfect Competition


Pric

e (d

olla

rs p

er s

wea

ter)

25

50

Sidney’s demandand marginal revenue:Firm

MR1

0 9 20

D1


Pric

e (d

olla

rs p

er s

wea

ter)

0 9 20

25

50

Sweater market:Industry

S

New marketdemandcurve

D2

20 MR2

Sidney’snew demandcurve

20

D3

19 MR319

Market Price = $19

FIRM INDUSTRY

41


Quantity(Q)

(sweaters/day)

Total Revenue

(TR) (dollars)

Total Cost(TC)

(dollars)

EconomicProfit

(TR - TC) (dollars)



Marginal Cost

(MC) (dollars)

0123456789

10111213

01938577695

114133152171190209228247

22456685

100114126141160183210245300360

045.0033.0028.3325.0022.8021.0020.1420.0020.3321.0022.27

2527.69

023.0022.0031.5019.5018.4017.3317.0017.2517.8918.8920.2723.1726.00

023.0021.0019.0015.0014.0012.0015.0019.0023.0027.0035.0055.0060.00

019.0019.0019.0019.0019.0019.0019.0019.0019.0019.0019.0019.0019.00

Marginal Revenue

(MR) (dollars)

New Price

-22-51-28-28-24-19-12

-8-8

-12-20-36-72

-113

FIRM

42

SR Economic Loss Minimization

MRMR


Pri

ce a

nd

co

st (d

olla

rs p

er s

wea

ter)

1919..000020.0020.00

25.0025.00

30.0030.00 MCMC

ATCATC

88 10 10 00

AVCAVC

lossloss

Loss Min,P=$19.00• MC = MR @ 8 units

ATC ($20) > P ($19); Losses = $8

• TFC = $22.00• Shut down,

lose $22.00• Produce, lose $8

• Minimize losses by producing when

• P >AVC < ATC

Market Price = $19

FIRM

43


Quantity(Q)

(sweaters/day)

Total Revenue

(TR) (dollars)

Total Cost(TC)

(dollars)

EconomicProfit

(TR - TC) (dollars)



Marginal Cost

(MC) (dollars)

0123456789

10111213

0163248648096

112128144160176192208

22456685

100114126141160183210245300360

045.0033.0028.3325.0022.8021.0020.1420.0020.3321.0022.27

2527.69

023.0022.0031.5019.5018.4017.3317.0017.2517.8918.8920.2723.1726.00

023.0021.0019.0015.0014.0012.0015.0019.0023.0027.0035.0055.0060.00

016.0016.0016.0016.0016.0016.0016.0016.0016.0016.0016.0016.0016.00

Marginal Revenue

(MR) (dollars)

New Price

-22-29-34-37-36-34-30-29-32-39-50-69

-108-152

FIRM

44

Short Run Shut Down

MRMR


Pri

ce

an

d c

os

t (d

oll

ars

per

sw

eate

r)

1616..0000

20.1420.14

25.0025.00

30.0030.00 MCMC

ATCATC

7 107 1000

AVCAVC

lossloss

Shutdown:P=$16.00• MC = MR @ 7 units• ATC (20.14) > P ($16): • Losses = $29.00• TFC = $22.00• Shut down, lose $22• Produce, lose $29

• Minimize losses by Minimize losses by

shutting down whenshutting down when PP AVC at MC = MR AVC at MC = MR

Market Price = $16

FIRM

45

Short Run Supply

• Def’n: Quantity that producers will produce at various possible prices in a set of prices, for a given time period: ceteris paribus.

• At each price a firm will produce the output for which MC comes closest to being equal to MR without MC exceeding MR &…….

FIRM

46

MR2

Profitpoint

A Firm’s SR Supply Schedule

Quantity (sweaters per day)7 8 9 10

17

25

31

Pric

e an

d co

st (

dolla

rs p

er s

wea

ter)

MC

MR3

MR0

Shutdown point

0

20

Break-evenpoint

MR1Minimizelosses

MC=Supply

47

“Supply”

The Short Run “supply” schedule of the firm is found to be the “MC” schedule

• but with 2 qualifications.

FIRM

48

•1.) Only the upward slopingpart of MCqualifiesas the SR “supply”• 2.) Only thatpart of the MC that lies above the AVC qualifies as the SR “supply”


Pri

ce a

nd

co

st (

dol

lars

pe

r sw

eate

r)

15.00

25.00

8 10

30.00

MR

MC

AVC

0

QualificationsFIRM

49

Market Supply

• Total amount provided to the market at each possible price…

»Or

• The marginal cost of providing additional output to the market, given current production conditions.

50

Market Supply• Note: In the SR, quantity supplied is positively

related to price for 2 reasons:

– As the market price increases,

• 1.) each firm uses its capital more intensively thereby increasing output, but also increasing marginal cost.

• 2.) firms that were previously providing output but had ceased production, to minimize losses, will find it profitable to begin production again, using capital that had been idle.

51

Problem: Perfect Competition.

1. The following tables give the costs and revenue for a firm in perfect competition.

2. What will the firm supply in order to maximize profits given the various prices in the market?

3. What is the industry supply if there are 100 firms in the industry?

4. What is the Market Price and Output?

52

Total Revenue, Total Cost, & Economic Profit

Quantity(Q)

(sweaters/day)

Total Revenue

(TR) (dollars)

Total Cost(TC)

(dollars)

EconomicProfit

(TR - TC) (dollars)



Marginal Cost

(MC) (dollars)

0123456789

1011121314

918273845546372819099

108117126

15222730323334363944516076

104144

-15-13

-9-36

122027333739393213

-18

022.0013.5010.00

8.006.605.675.144.884.895.105.456.338.009.21

7.006.005.004.253.603.173.003.003.223.604.095.086.859.21

75321123579

162840

Marginal Revenue

(MR) (dollars)

P=$9.00=MR

9.009.009.009.009.009.009.009.009.009.009.009.009.009.00

Documents

Short Run