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M18.L05 — Short-Run and Long-Run Firm Behaviour

Module: Module 18 — Technology, Production, and Profit Maximisation Lesson: L05 of 05 Duration: ~30 minutes Level: Intermediate Provenance: Intermediate Microeconomics with Excel (Barreto) | MIT OCW 14.01 Principles of Microeconomics

Learning Objective

Compare short-run and long-run cost curves and firm supply decisions.

Short-Run vs. Long-Run

  1. Short-Run: At least one input is fixed (e.g., capital).
  2. Cost Minimization: Constrained by fixed input.

  3. Supply Decision: Produce if \(p \geq AVC\); shutdown otherwise.

  4. Long-Run: All inputs are variable.

  5. Cost Curves: LRAC is the envelope of SRAC curves.
  6. Supply: More elastic than short-run (Le Chatelier principle).

Key Relationships:

  • Shutdown vs. Exit:
  • Short-run: Shutdown if \(p < AVC\).
  • Long-run: Exit if \(p < AC\).
  • Le Chatelier Principle: LR supply is more price-responsive than SR supply.

Worked Example

[Australian context]

An Australian dairy farm has: - Short-Run: \(C_{SR}(y) = 100 + 2y^2\) (fixed cost = 100 AUD). - Long-Run: \(C_{LR}(y) = 3y^2\).

  1. Short-Run Supply: [ MC_{SR} = 4y = p \implies y_{SR}^*(p) = \frac{p}{4} ] (For \(p \geq AVC_{min} = 0\)).

  2. Long-Run Supply: [ MC_{LR} = 6y = p \implies y_{LR}^*(p) = \frac{p}{6} ] More elastic than SR supply.

Common Misconception

"Firms always produce at minimum ATC in the short-run."

Only true in long-run equilibrium. Short-run production may deviate due to fixed inputs.

Key Takeaways

  • Short-run decisions are constrained by fixed inputs; long-run allows full adjustment.
  • LRAC envelopes SRAC curves, reflecting flexibility.
  • Le Chatelier principle: LR responses are more elastic than SR.

Practice

  1. For \(C_{SR}(y) = 50 + y^2\), find the shutdown price.
  2. Sketch SRAC and LRAC for a technology with economies of scale.

Further Resources

Provenance: Intermediate Microeconomics with Excel (Barreto) | MIT OCW 14.01 Principles of Microeconomics