Economics Short Run Vs Long Run Costs Questions Medium
The concept of marginal cost refers to the additional cost incurred by a firm to produce one more unit of output. It is calculated by dividing the change in total cost by the change in quantity produced. Marginal cost plays a crucial role in determining a firm's production level as it helps in optimizing the production process and maximizing profits.
In the short run, a firm's production level is influenced by the marginal cost. Initially, as the firm increases its production, the marginal cost tends to decrease due to economies of scale and specialization. This is because fixed costs, such as rent and machinery, are spread over a larger quantity of output, resulting in lower average costs. As a result, the firm can increase its production level to take advantage of lower marginal costs and maximize its profits.
However, beyond a certain point, the law of diminishing returns sets in, causing the marginal cost to increase. This occurs when the firm starts experiencing diminishing marginal productivity, meaning that each additional unit of input contributes less to the total output. As a result, the firm's production level should be reduced to avoid incurring higher marginal costs, which would lead to lower profits.
In the long run, a firm has more flexibility to adjust its production level and factors of production. It can modify its plant size, hire or fire workers, and change its production techniques. In this case, the firm's production level is determined by the minimum efficient scale, which is the level of output where the average cost is minimized. The marginal cost still plays a role in determining the firm's production level, as it helps in identifying the point where the average cost is minimized.
To summarize, the concept of marginal cost is essential in determining a firm's production level. In the short run, it helps in optimizing production by taking advantage of economies of scale and avoiding diminishing returns. In the long run, it assists in identifying the minimum efficient scale and minimizing average costs. By considering the marginal cost, a firm can make informed decisions about its production level and maximize its profitability.