Factors that affect short run production
Upward sloping supply curve characterizes short run production. The supply curve emanates from the law of diminishing marginal utility. The law states that as additional units of variable factors are added to the fixed factors of production, output rises but eventually falls. Producer’s response to price changes depends on the production function. Some of the environmental factors that affect short run productions are variable factors such as changes in unit labor cost, changes in commodity prices, changes in exchange rate, government taxes and subsidies, and changes in price of imports.
The management needs to ensure that there is adequate buffer stock of raw material so that changes in variable factors do not impact on short run production. Secondly, management needs to operate in the region where the diminishing marginal rate of productivity is rising.
Shut down in the short run and long run
This discussion assumes that the company produces soft drinks. Assume that the price of the soft drinks falls due competition and the cost of production increases. The company can stop operations in the short run when the revenue generated from the sale of soft drinks cannot cover the variable costs of production. In the long run, the company stops operating the total revenue cannot cover total cost or when average costs exceed price. A firm’s goal is to maximize profits. When costs exceed revenues, then the firm is no longer profitable.
Distinction between short run and long run production
Short run is a period when some factors of production cannot be varied. This production period in economics is not fixed. It varies from industry to industry depending on the firm’s ability to vary factors of production. The law of diminishing marginal utility explains the short run production function. In the long run, management can vary all the factors of production. The analysis assumes that the company produces shoes. The costs functions for production of the shoes are total cost function, average cost function and marginal cost function.
The above graph shows both the short run and long run cost functions. It assumes that the firm experiences constant returns to scale in the long run. Changes in price cause movements in the short run curves. In the long run, changes in price cause shifts in the long run curves.
Fixed and variable costs
The variable costs of producing the shoes are direct materials, direct labor and direct overhead. The fixed costs are land, plant and machinery. The management estimates profitability of the product using marginal costing.
Marginal Costing Cost Statement
From the table above, the contribution margin per unit is $5.1. With the assumed annual sales of 50, 000 units for the first year, the contribution margin amounts to $ 753,000. The fixed cost of $ 498,000 is adjusted to get the net profit of $ 255,000, which works out to 20% of the total sales revenue for the first year. Based on the analysis above, production of the shoes is viable.