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Lecture 4

Lecture Fourteen: Making Decisions in the Short and Long Run

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ECON 1000
George Georgopoulos

Lecture Fourteen: Making Decisions in the Short and Long Run November 17, 2011 Decision Time Frames The firm makes man decisions to achieve its main objective: profit maximization Some decisions are critical to the survival of the firm - Some decisions are irreversible or very costly to reverse Other decisions are easily reversed and are less critical to the survival of the firm, but they still influence the profit. All decisions can be placed into two time frames - The short run - The long run The Short Run The short run is a time frame in which the quantity of one or more resources used in production is fixed. - The time that it takes to change the quantity of the short run is considered to be the short run For most firms, the capital, called the firms plant, is fixed in the short run. Other resources used by the firm (such as labour, raw materials an energy) can be changed in the short run. Short run decisions are easily reversed. The Long Run The long run is a time frame in which the quantities of all the resources, including plant size, can be varied Long run decisions are not easily reversed A sunk cost is a cost incurred by the firm and cannot be changed - If a firms’ plant has no resale value, the amount paid for it is the sunk cost - Start up costs of opening a business also are sunk costs because you do not get that money back when you decide to close the business Sunk costs are irrelevant to a firm’s current decisions Short Run Technology Constraint To increase output in the short run, a firm must increase the amount of labour employed. There are three concepts to describe the relationship between output and the quantity of labour employed: 1. Total Product 2. Marginal Product 3. Average Product Product Schedules Total Product is the total output produced in a given period The marginal product of labour is the change in total product that results from a one unit increase in the quantity of labour employed, with all other outputs remaining the same The average product of labour is equal to total product divided by the quantity of labour employed As the quantity of labour employed increases, - Total product increases - Marginal product initially increases, but eventually decreases - Average product initially increases, but eventually decreases One of the reasons to explain this is that during this time, the firms capital resources (such as machinery or technology) is remaining the same. Therefore there might not be enough equipment compared to the amount of people working. As marginal and avera
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