Reference no: EM1370613

The short run is decision making period during which at least one input is considered fixed. The fixed input is generally considered to be some aspect of capital, such as the production facility or it could be a normally variable input that is fixed due to production technology requirements, or it could be a contractual commitment, such as a facility lease, related to production. In essence, when one refers to short-run analysis, the analysis is focused on a planning period in which some input is fixed and the others are variable. In the short-run, the manager selects the levels of variable input and production output to optimize profits given the constraint of the fixed input.

In the short-run, does a firm become cost-effective and efficient by increasing its volume of production?

A firm does not necessarily become cost-effective and efficent by increasing its volume of production in the short-run unless it has a good understanding of the law of diminishing returns. The law of diminishing returns states that beyond some point the marginal product decreases as additional units of the variable factor are added to the fixed factor. To become cost-effective and efficient, a firm would have to compute the optimal number of workers that should be employed to achieve the level of production that would maximize profit. The rationale behind this would be as follows. The first group of workers hired divide the work between them and become specialized and achieve the increasing returns. The diminishing returns begin and continue when more workers are added. The added workers must share the machinery. Some workers could become under-employed as they are waiting for the availability of the machinery. Consequently, the marginal products could become negative.