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Chapter 13 - Chapter 13 Production Decisions in the Short...

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Chapter 13 Production Decisions in the Short and Long Run Suppose you are happily profit maximizing in your firm that produces economist cards using labor and capital. 1 Suddenly you realize that a new government regulation has increased your cost of employing workers. If capital is fixed in the short run, then you now find yourself in the world of Chapter 11 – making decisions along a short run production frontier that has output changing solely with the number of workers you employ. As we have seen in Chapter 11, you will now employ fewer workers and will therefore produce fewer economist cards. But as time passes, your firm will have a chance to make some more decisions because it will have the opportunity to change the amount of capital it is using – and then to re-evaluate whether it wants to hire more or fewer workers. Now you begin to find yourself in the world of Chapter 12 where both labor and capital can be adjusted to meet the new economic conditions in the labor market. Your firm’s short run problem, it turns out, is a “slice” of the more complex long run problem you eventually face as time passes. Between this and the next chapter, our focus now turns to how your firm will transition from the short run (of Chapter 11) to the long run (of Chapter 12) as underlying conditions change. More generally, we will ask how changes in the economic or technological environment will affect the decisions by producers over time. By the “economic environment” we will continue to mean the output and input prices that price-taking producers take as given as they try to do the best they can, and by the “technological environment” we will mean the technological processes that permit inputs to be converted to outputs as summarized by the production frontier. In the short run, we will typically assume that capital is fixed and labor is variable – but of course this mirrors an analysis where labor is fixed in the short run and capital is variable. And, we will begin to introduce a new type of “fixed” cost for firms – a cost that is not associated with an input like labor or capital. Our main focus in this chapter, however, remains on a firm’s economic response to changing input and output prices – while the next chapter will consider the underlying causes of such changes in prices within a competitive industry. 1 This chapter contains some of the most challenging material in the text and instructors may wish to be selective about which part to use. Chapters 11 and 12 are necessary reading for this chapter. Analogies to substitution effects in the consumer model (Chapter 7) also appear. Upcoming Chapters make use mainly of material in Section 13A.1.
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422 Chapter 13. Production Decisions in the Short and Long Run 13A Changes in Producer Behavior as Conditions Change We have already seen that it is often convenient to view profit maximizing firms initially as cost minimizers who then use information on output prices to determine the production plan at which the difference between revenues and costs is greatest. As we begin to consider how price taking firms
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