Cambridge International as and a level Economics Ebook

152
Cambridge International A Level Economics

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Th
is gives the classic ‘U’ shape to the ATC curve. On a 
graph of cost data, the MC will always cross AVC and 
ATC at their lowest points. In this situation, the most 
effi
cient output for the fi rm will be where the unit cost 
is lowest. Th
is is known as the optimum output. It is 
where the fi rm is productively effi
cient in the short run; 
the most effi
cient output is not necessarily the most 
profi table since profi t maximisation may only be possible 
in the long run. For a fi rm wishing to maximise its 
profi ts, its chosen output will depend on the relationship 
between its revenue and its costs.
TOP TIP
Decision making by firms is very dependent upon 
marginal cost. The significance of this will become clear 
in the rest of this chapter.
From short-run to long-run
As stated above, the short run is a period of time in 
Economics when at least one of the factors of production 
is fi xed. Th
e factor that tends to be easiest to change is 
labour as we have already seen. Th
e factor that takes 
longest to change is capital. Students oft en ask the 
question, ‘How long is the short run?’ Th
is is not an 
easy question to answer, as it tends to diff er for diff erent 
industries. In the clothing industry it is likely to be no 
more than a few weeks: the time that is taken to install 
new machines and to get these operational to produce 
clothing. In other industries, it will be much longer. A 
country building a new hydroelectric power station will, 
for example, take much longer to plan, install and make 
such a new facility operational. Ten years may well be a 
realistic estimate in this case. Th
is time is still referred 
to as the short run since capital is fi xed over this time. 
So, the short run is 
not
defi ned in terms of a specifi c 
period of time; it refers to the time when not all factors of 
production are variable.
All factors of production are variable in the long 
run. Th
is gives the fi rm much greater scope to vary the 
respective mix of its factor inputs so that it is producing 
at the most effi
cient level. So if capital becomes relatively 
cheaper than labour or if a new production process is 
invented and this increases productivity then fi rms can 
reorganise the way in which they produce. Firms must 
therefore know the cost of the factors of production they 
use and see this in relation to the additional product that 
accrues. Knowing costs is quite easy in the case of labour 
and some other basic inputs; it is more diffi
cult to estimate 
for other factors of production. Th
e best combination of 
factors can be arrived at as their price varies. Firms should 
aim to be in a position where:
marginal product marginal product marginal product
factor A
price of facto
ff
r A
factor B
price of facto
ff
r B
factor C
price of
=
=
factor
ff
C
and so on for all factors of production they use. For them to 
be able to do this all factors of production must be variable.
If we go back to the principles introduced in 
Figure 7.6,
it is possible to derive the long-run production function 
for a fi rm by initially constructing an isoquant map. Th
is 
shows the diff erent combinations of labour and capital 
that can be used to produce various level of output. Th
is is 
shown in 
Figure 7.9.
Let us again assume that this is for a clothing 
manufacturer. 
Figure 7.9a 
consists of a collection of 
isoquants for output levels of 100, 200, 300, 400 and 
500 units of production. From this it is possible to read 
off the respective combinations of labour and capital that 
Labour
0
Capital
Labour
0
Capital
Long-run production function
500
400
300
200
100
(a) Isoquant map
(b) Long-run production function