Micro Economics Short Run Versus Long Run free essay sample

This paper will discuss the short run competitive equilibrium versus the long run competitive equilibrium and the differences between the short run and long run shut down decision of a firm. 2. Short run versus long run competitive equilibrium in an economy with production Theory Market equilibrium exists when the total amount the firms wish to supply is equal to the total amount the consumers wish to demand. In a diagram, the equilibrium price is the price at which the demand and supply curves cross. The long and the short run do not refer to a specific period of time such as three months or five years. The difference between the two is the flexibility decision makers have. Economics of Parkin and Bades gives an excellent distinction between them: The short run is a period of time in which the quantity of at least one input is fixed and the quantities of the other inputs can be varied. We will write a custom essay sample on Micro Economics Short Run Versus Long Run or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page The long run is a period of time in which the quantities of all inputs can be varied. 2. 2Short run supply curve A perfectly competitive firms supply curve is that portion of its marginal cost curve that lies above the minimum of the average variable cost curve. A perfectly competitive firm maximizes its profits by choosing to supply the level of output where its marginal revenue equals its marginal cost. When marginal revenue exceeds marginal cost, the firm can earn greater profits by increasing its output. When marginal revenue is below marginal cost, the firm is losing money, and consequently, it must reduce its output. Profits are therefore maximized when the firm chooses the level of output where its marginal revenue equals its marginal cost. 2. 3Long run supply curve The long-run supply curve is determined by the long-run competitive equilibrium. The optimal level of output is the point where price equals the minimum of average costs of production and where price equals marginal cost. At the point known as the long-run competitive equilibrium, each firm’s profits are exactly enough to cover the average costs of production and economic profits are zero. Below is a graphic representation of this relationship. As is shown in above graph, the long-run competitive equilibrium (Pe) is where price equals the minimum average costs (AC) and where price equals marginal cost (MC). 3. Short run shut down decision versus long run shut down decision When the firms average total cost curve lies above its marginal revenue curve at the profit maximizing level of output, the firm is experiencing losses and will have to consider whether to shut down its operations. The firm must pay its fixed costs, considered sunk costs, regardless of whether it produces any output. If the firms average variable costs are less than its marginal revenue at the profit maximizing level of output, the firm will not shut down in the short-run. The firm is better off continuing its operations because it can cover its variable costs and use any remaining revenues to pay off some of its fixed costs. In the long-run, a firm that is incurring losses will have to either shut down or reduce its fixed costs by changing its fixed factors of production in a manner that makes the firms operations profitable. The firms short run shut down decision 4. Real life application American Italian Pasta Company is a Delaware corporation and commenced its operations in 1988.. Richard C. Thompson, the founder from the start, decided to focus on producing premium-grade pasta and avoid competing against low-priced, mass-produced brands manufactured by such industry giants as Hershey Foods and Borden. Thompsons strategy hinged on something that would make his company a rarity among U. S. pasta producers. Most manufacturers purchased their pasta flour from commercial mills, rather than producing it on their own, but from the start Thompson preached vertical integration, striving to realize the financial benefits of owning his own flour-making facility and the greater control over quality such ownership would give him. He decided to build his production plant in Excelsior Springs, Missouri, selecting the location because of the presence of pure spring water and, more important, because of Excelsior Springs proximity to rail lines accessing North Dakota durum. The $50 million, state-of-the-art facility began production in 1988, officially making Thompsons AIPC a participant in the growing pasta industry. By 2004 the company was the largest producer of dry pasta in North America, with revenues of $417. 4 million. With more than 220 dry pasta shapes vertically-integrated facilities, continued technological improvements and development of a highly-skilled workforce they produce high-quality pasta at costs below those of many of the competitors. The demand for pasta, prompted AIPC to increase its production, order more raw materials a variable input. The same applies to labor, but the plants and the equipment on the other hand, would be the fixed input. The short run is the period in which production is increased by adding more raw materials and more labor. In the short run we cannot add another factory, but in the long run all of our inputs are variable, including our factory space. The increase in demand for pasta will have different implications in the short run and the long run at the industry level. In the short run each of the firms will increase their labor supply and raw materials to meet the added demand for pasta. At first only existing firms will be likely to capitalize on the increased demand as they will be the only ones who will have access to the four inputs needed to make the pasta. However in the long run the factor input is variable as well.