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Unformatted text preview: C H A P T E R 13 Production Decisions in the Short and Long Run We already saw in Chapter 12 that the single-input model in Chapter 11 was just a slice of the 2-input model with capital held fixed. We now build on this insight illustrating how short run constraints inhibit immediate adjustments to long run production plans as underlying conditions change. We also find ways of connecting short and long run cost curves and illustrating the difference between short run and long run profit. Throughout, we try to be very consistent in the following sense: We only call something a cost if it is really an economic cost and we reserve the terms expenditure or expense for outlays that include sunk costs. This is a departure from the typical way in which textbooks treat costs but I think it actually makes a lot that follows easier and less confusing while focusing us on what we really mean by economic costs (and economic profit). Chapter Highlights The main points of the chapter are: 1. Not every financial outlay by a firm is an economic cost for the firm. Eco- nomic costs include only opportunity costs i.e. only those outlays that ac- tually affect economic behavior. If we include in costs only real economic costs , then it will always be the case that the supply curve is the part of the MC curve that lies above AC . 2. The financial outlays on capital are fixed in the short run and are therefore not a short run cost because they have to be paid regardless of what the firm does. These outlays become a variable cost in the long run because capital can be varied in the long run. There are really no such things as fixed costs in the short run, but there may be such costs (like recurring license fees) in the long run. Production Decisions in the Short and Long Run 264 3. Firms will produce (on their short run supply curves) and not shut down so long as short run profit is not negative, and firms will produce (on their long run supply curves) and not exit the industry so long as long run profit is not negative. Both short and long run profit subtract economic costs from rev- enue, but what counts as an economic cost differs between the short and long run (because some financial outlays that are costs in the long run are sunk in the short run). As a result, the (short run) shut down price is lower than the (long run) exit price . 4. Output supply responses to a change in output price are larger in the long run than in the short run implying that long run supply curves are shal- lower than short run supply curves. Similarly, input demand curves are shal- lower in the long run than in the short run . 5. Output supply curves shift as input prices change to the left as they in- crease and to the right as they decrease. Similarly, input demand curves shift as output prices change to the left as output price falls and to the right as output price increases....
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- Fall '08