University of Westminster

Question 2.
In production process, firms turn inputs into outputs in different ways, using combination of labor, capital and materials. Since firms must consider whether inputs can be varied, if it can be varied, it is important to identify the difference between short run and long run production function when analyzing. In the short run production function, it refers to a period of time in which one factor of production is fixed, for example, capital. This means that if a firm wants to increase output, it would employ more employees, bot it could not increase capital in the short run. Thus, in the short run, we can get diminishing marginal returns, and marginal costs start to increase quickly. Also, in the short run, it is possible to see price and wages out of equilibrium. For example, a sudden rise in demand may result in higher costs, but businesses are incapable of reacting and increasing supply.

In the long run production, it means the amount of time needed to all inputs variable, meaning that all factors of production are variable. In this case, a firm has time to build a bigger its branch and respond to changes in demand. In the log run, a firm can enter or leave a market.

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  SRAC = short run average costs
  
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  LRAC = long run average costs
  

This illustrates how the long-run average costs of a business are affected by various curves of short-run average costs (SRAC).

Due to diminishing returns in the short term, the SRAC is u-shaped.

An rise in the supply of money will lead to a short-term increase in real output, as employees feel that real revenue is growing. However, the rise in the supply of money triggers inflation in the long run, because employers know that real wages are the same and that real production remains unchanged.