Tag Archives: short run

Technological advance: invention, innovation, and diffusion.

31 Jul

technological advantage
       In economics technological advantage is new and better goods and services and new and better ways of producing or spreading them. This process occurs over a theoretical time called very long run, than can be as short as few weeks or as long as many years. Let’s recall that in all our market systems (pure competition, monopolistic competition, oligopoly and pure monopoly), the short run is a period in which technology, plant are fixed, however in the long run , technology is constant but the firms can change their plant size and are free to enter and exit the industry. In contrast, very long run is a period in which technology can change and firm can develop and supply totally new products.
   It’s known that technological advantage shifts product possibility curve upward, enabling economy to achieve more goods and more services. Technological advantage can be is made up of three parts: invention, innovation, and diffusion.
   The first step to technological advantage is invention: the discovery of product or process of producing by using imagination, thinking and experimenting. Invention is a process and the result of it is also called invention. Invention is based in scientific knowledge and it is the result of work of individuals who work on their own or as members of Research and Development (R&D) departments in firms. Government encourages invention by providing patents, right to sell any innovative process of production, machines or products in a set time.
Innovation is directly related to invention. While invention is “discovery and proof of workability”, innovation is the successful introduction of new product (invention) in the market, the first use of a new method of producing, or the creation of new form of business firm. There are two types of innovation: product innovation, improving products and services, and process innovation, which is improved ways of production and spreading of these inventions in the market.
In contrast to invention, innovations cannot be patented. Innovation needs not to weaken or destroy the existing firms. Because new products and processes threaten firms’ survival, existing firms have a high incentive to engage into research and development (R&D) process continuously. These innovative products and processes enable firm to earn higher revenue or to maintain the present ones. Innovation can strengthen or weaken market power.
   Diffusion is the process of spreading of inventions through imitating or copying. To take the advantage of new profits or to slow down disappearing of others, all firms try to implement the innovations. In most of the cases innovation leads to widespread imitation (that’s diffusion) of inventions. For example, soon after McDonald’s introduced the fast-food hamburger, Burger Kings also started to produce it, since it offered high revenues for the firms that supplied this good.
Research and Development (R&D) Expenditures
When it’s related to business research and development means the efforts towards inventions, innovations and diffusion. Many countries engage in R&D of national defense, so that annually they spend thousands of billions of dollars.
Importance of Technological Advantage
   Technological advances for many centuries were viewed ad external to economies, like a force to which economies adjust. Periodically new advances in scientific and technological knowledge occurred. Firms and industries, incorporated new technology into their products and production process to increase or to maintain their revenues. After making some adjustments, they continue to settle into long-run equilibrium position. Economists believe that technological advantage is related to advance of science, which is very important for market system. Some of economists see capitalism is the as driving force of technological advantage. Technological advantage arises from rivalry among individuals and firms that motivates them to seek and exploit new opportunities of profit and of expanding. This rivalry occurs between new firms and existing ones. Entrepreneurs and innovators are viewed as heart of technological advantage.


Short Run Production Costs

8 Jul


   Production information must contain resource prices in order to determine total and per unit price of diverse amount of output. It’s known that in short run prices are associated with plant’s variable resources. Its capital resources are limited so we shouldn’t consider them. Short run costs can be either variable or fixed. So let’s describe them:
Fixed Cost: these costs don’t vary with changes in output. These costs must be paid even if the firm doesn’t produce anything. Such costs may be: rental payments, interests of firm’s debts, money paid for insurance. These costs are paid even when the firm has zero output, so firm can’t avoid paying these costs.
Variable Cost:
 These costs vary with the change in output. They include payment for raw material, fuel, wages, transportation prices, fuel etc. These payments vary directly with output. As the production begins variable costs will increase by a decreasing amount, but after a point they will rise by an increasing amounts (as a result of law of diminishing marginal returns) also this reason lies in the shape of Marginal Product (MP) curve, which is increasing with smaller and smaller amounts and when diminishing returns are encountered marginal product begin to decline, so larger and larger amounts of variable resources are needed to produce a successive unit of output. Total variable cost then is increasing by an increasing amount.
Total Cost:
Economists call sum of fixed costs and variable costs as total costs. At zero unit of output total costs are equal with fixed costs. Graphically, amount of vertical Total Fixed Cost (TFC) summed with vertical value of Total Variable Cost (TVC) should result in Total Cost (TC).
For business manager these distinctions between fixed and variable costs are very important. Variable costs can be controlled or changed by changing production levels in short-run. However, fixed costs are beyond control of business manager, because they are included in short run and must be paid regardless the output level. In short run firms can’t get out of industry and leave the market.

 Per-unit and Average Costs:
 Average fixed cost (AFC) is found by dividing total fixed cost by output quantity (Q):
Average Fixed Cost Formula

Because Total fixed Cost by definition is the same regardless of output, then AFC curve will decline as output increases,because as output quantity increases Total Fixed Cost (TFC) is spread over a larger output produced. Q≠0.

Average Variable Cost (AVC): for any output quantity (Q≠0) is calculated by dividing Total Variable Cost (TVC) by Quantity output (Q):

Average Variable Cost
As added more variable resources increase output, average variable cost (AVC) declines initially, reach a minimum and then increases again, so AVC curve is U shaped. It can be explained by the fact that AVC (also TVC) curve reflects law of diminishing returns.

  To explain in simple terms, at very low levels of output, production is inefficient because of high-costs and low quantity produced. Initially, since firm is understaffed, average variable cost is relatively high. As output expands greater level of specialization, greater division of labor and better use of firm’s capital occurs. However, when we still add more variable resources, a point is reached when diminishing returns are incurred. Also the firm is being overstaffed so each additional unit of variable resource doesn’t increase marginal product (MP) as before.

    Average Total Cost (ATC) for any output level is found by dividing Total Cost (TC) by output (Q) or by adding average variable cost (AVC) and average fixed cost (AFC):
Average Total Cost Formula
Graphically ATC can be found by adding vertically average variable cost (AVC) and average fixed cost (AFC). Q≠0. 

Marginal Cost
  Marginal Cost is the additional cost of producing one more unit of output. Marginal cost can be found by following formula:
Marginal Cost formula
Marginal Cost is important for firm’s managers because a firm can control it immediately. It is used to find the cost of production of an additional product, so it helps to save some money if the firm doesn’t produce this unit (because of the loss that may occur at production).

Economic Costs

7 Jul

Economic Costs

   Goods or resources have price because they are scarce and may have alternative uses. When a society uses resources to produce a specific good, it loses (forgoes) the opportunity to use this good for any other purpose. Economic cost or opportunity costs measure the value or worth of a good that would have in its best alternative use.

Explicit and Implicit Costs
   Now let’s consider costs from a business viewpoint. Keeping opportunity costs in mind, we may say that economic costs are payments that a business must make or income it must provide, to attract resources it needs from alternative uses. These payments to resource providers may be explicit (expressed) or implicit (present but not obvious). So firms have both implicit and explicit costs while they are producing goods:

  • A firm’s explicit costs are payments that it makes for labor force, resources, transportation of goods and so on.
  • A firm’s implicit costs are the opportunity cost for the goods it owns and it produces. They are the monetary payments that those resources could have earned if they were used in their best alternative uses.

       Normal Profit
            Normal profit (an implicit cost for firms) is the monetary payment that a firm must make to obtain and retain entrepreneurial ability also we may call it as minimum payment entrepreneurial ability must receive to perform the entrepreneurial activity for a firm. For example if you are entrepreneur and you didn’t receive this minimum payment for your effort you could easily withdraw from a business and move to a more attractive one.
   Economists include as costs of production all payments- implicit (including normal profit) and explicit, which are required to attract resources in a specific economic unit.

Economic Profit
     To economists, economic profit is the difference between total revenue (TR) and total costs (TC) (implicit and explicit). So when it is said that a firm receives normal profit, it means that it receives the money needed to cover it costs (implicit and explicit) and the entrepreneur is receiving payments large enough to retain his abilities in this production line.


Economic profit is not a cost, better said it is excess revenue offered to entrepreneur in his line of production.

Economic Costs

Short Run and Long Run
   When firm’s demand changes its profit may depend how quickly it can adjusts to various amount of resources it employs. It can quickly adjust the quantity of resources employed of labor, fuel, resources. However, to adjust plant capacity (size of factory, amount of equipment and machinery and other capital resources) more time it’s needed. For example in heavy industries time needed to increase plant capacity can be very long. That’s why economists distinguish two conceptual periods: long run and short run.
Short Run
       In short run plant capacity is assumed to be fixed because period of time is too short; however it is enough to perform several changes in the method how the fixed plant is used. For example, firm may vary the quantity output by applying different amount of labor force, materials and other resources needed to that plant.

Long Run
      Long run is a period long enough to adjust all quantities of resources that a firm needs even a change in plant’s capacity can occur. For industry, long-run is the period of time in which firms can also leave or enter the industry. While short run determines “fixed-plant” period, long run determines “variable-plant” period.

Elasticity of Supply

4 Jul

Cross elasticity of supply
   Supply also can be determined by price elasticity. If producers are responsive to a change in price then supply is elastic. If they are insensitive to price change then the supply is inelastic.
   In economics elasticity of supply is denoted by Es, but there is a change in our elasticity of demand formula:
Elasticity of supply
    Like Ed, if Es is smaller than one, then the supply is inelastic. However, if Es is smaller than one then the supply is inelastic.
   The main determinant of elasticity of supply is time they have to respond to an increase in demand. Shifting resources takes time, more time available- greater ability to shift resources. The impact that time can have on elasticity of supply is distinguished among the immediate market period, short run, and the long run.

   Market Period
        Market period is that amount of time in which suppliers are unable to respond to an increase in demand and in price of a good. Suppose an owner of a small goat farm has 100 liter produced in the whole week and he bring all this quantity of milk to the market to sell. The supply curve is perfectly inelastic (vertical). This farmer will sell all his milk whether the price is high or low. Why? Because the farmer can offer only this quantity of milk in this milk even if the price is very high. Another week in needed to collect more milk, so he needs some time to respond to the increase in demand. Also, because the product is perishable he can’t keep it away for some time from the market. If the price is smaller than anticipated this farmer also has to sell all this quantity of milk.
   As we can see farmer’s cost of production, won’t enter into decision to sell, because he has to sell all his production in order to avoid total loss. During market period our farmer’s quantity of supplied milk is fixed, no matter how high or low the price can be.
   However, not all supply curves are perfectly inelastic immediately after a price change. If the good is not perishable and price rises, then the producers may choose to increase quantity supplied by drawing down their inventory unsold, stored goods causing market supply to get more quantity of that good.
         For our farmer this market period can be one week, however, for producers of some goods that can be inexpensively stored, there may be no market period at all.
  The Short Run
         In short run, the plant capacity of some producers or of the entire industry is fixed. In the short run, our farmer’s farm is fixed, but he may give more food and more nutrients for his goats which may result in a somewhat higher output. In this case, an increase in demand is met with an increase in supply, which results in a smaller price adjustment than in the market period.
The Long Run
   The long Run is period long enough for firms to adjust their plant size and new firms to enter the industry. In milk industry for example our farmer can buy more land, more goats and more labor force. Moreover, other farmers may be attracted by high revenue possible to get in milk industry and to enter it. Such adjustments make a higher supply in response to an increase in demand.

Cross Elasticity of Demand
      The cross elasticity of demand measures how sensitive consumer purchases of the products let’s say “A” are to a change in price of the good “B”.

 Cross elasticity of income

  This formula helps us understand easier the concepts of complementary and supplementary goods.
 Substitute Goods
   If cross-elasticity of demand is positive, meaning that sales of A move in the same direction as a change of B, then A and B are substitute goods. Example: An increase in price of X causes consumers to purchase more Y.
Complementary Goods
   When cross-elasticity is negative, we know that X and Y are complementary, an increase in price of one cause demand for another to decrease.
Independent Good
   A zero or near-zero cross elasticity shows that two products are unrelated also called independent good.  Example: wristwatches and apples, glasses and walnuts.

Income elasticity Demand
       Income elasticity demand measures how demand of a product is affected by an increase of income. The coefficient of income elasticity demand, Ei ,  can be found by following formula:

Income elasticity of demand

Normal goods
    For most goods, the income elasticity coefficient Ei is positive, meaning more of them are demanded as income increases. Such goods are called normal or superior goods.
Inferior goods
   Negative income elasticity shows an inferior good. Ex: used clothes, long-distance bus tickets.
Table at Cross and Income Elasticity of Demand:
Table at Cross and Income Elasticity of Demand

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