Monday, 1 November 2010

Short-run costs

What does ‘short-run’ mean?
This is when a firm has one of more fixed factors of production (input). This is usually capital.
 What is the implication of this?
  • That even if output costs are zero fixed costs still exist e.g. premises and this relates to ‘land’ the factor of production.
  • As firms cannot make all the adjustments/changes they would like to in the short-run (given that one input is fixed), eventually costs rise so much that increasing output becomes inefficient and in more simple terms pointless.
  • Marginal cost is the cost of producing one extra unit and given that at least one factor of production cannot increase e.g. we cannot increase the size of our premises marginal cost rises. This forces average costs to rise as average cost is the cost of producing one single unit.
  • All of this comes down to the law of diminishing returns.
What is the law of diminishing returns?
Well for starters this only occurs in the short-run because land, labour or capital is fixed. So lets say that land is fixed like in above example - we cannot increase it. This means that no matter how many machines we get or employees we employ there is will be a maximum efficient level we can produce at. This is where all costs are minimised i.e. marginal cost = average cost. The economic term for this is productive efficiency. What happens if we try to increase output after this point;  is when we employ more workers productivity decreases because workers become less motivated as the don’t feel rewarded as much, they get on top of each other not enough space to work and they will probably have to work overtime. This all increases costs thats why MC increases and subsequently AC.

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