The short run, the long run and the law of diminishing returns

Overview

Production period a short run rather than a long run, law of diminishing marginal returns say and marginal product usually rise before it falls.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What makes a production period a short run rather than a long run?

   Model answer

   In the short run at least one factor of production is fixed in quantity, so output can only be changed by varying the factors that are flexible, usually labour and raw materials. In the long run every factor, including plant, machinery, buildings and land, can be varied, so the firm can change its entire scale of operation. The distinction rests on which inputs can be altered, not on a set number of weeks or months.

2. 2

   Why is the short run a much longer period of calendar time for a shipbuilder than for a window-cleaning business?

   Model answer

   The short run lasts as long as it takes to change the quantity of the least flexible factor. A window-cleaning firm can buy another van and ladder within days, so its long run arrives almost at once. A shipyard may need several years to commission a new dry dock, so its short run stretches over years. Calendar length therefore follows from how quickly capital can be added, and varies from industry to industry.

3. 3

   A brewery can hire more staff tomorrow but cannot install a new fermentation vessel for eighteen months. Is it operating in the short run or the long run?

   Model answer

   It is operating in the short run, because capital is fixed while labour is variable. Any extra output over the next eighteen months must come from working the existing vessels harder with more labour. Only once the new vessel can be installed does the firm reach its long run, at which point every factor is variable.

4. 4

   What is the difference between a factor being fixed and a factor being fully used?

   Model answer

   A fixed factor is one whose quantity cannot be changed within the period under consideration, regardless of how intensively it is worked. A factory building is fixed even if half of it stands empty, because the firm cannot alter the amount of building it has. Being fully used is about the rate of utilisation, whereas being fixed is about whether the quantity itself can be varied.

5. 5

   What does the law of diminishing marginal returns say?

   Model answer

   As successive units of a variable factor are added to a fixed factor, the marginal product of the variable factor will eventually fall. The law applies only in the short run, because it requires at least one factor to be held constant. Marginal product may rise at first, but beyond some point each additional unit of the variable factor adds less to total output than the one before it.

6. 6

   Why does the law of diminishing marginal returns apply only in the short run?

   Model answer

   The law depends on adding more of a variable factor to a fixed quantity of another factor, so that each extra worker has less capital or land to work with. If every factor can be increased together, as in the long run, no factor is being spread more thinly and the law has nothing to bite on. Long-run changes in unit cost are therefore explained by returns to scale, not by diminishing returns.

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