Question

5. Output price and supply in the short and long run Aa Aa E Consider a firm that is originally producing along the isoquant corresponding to 800 units of output using the cost-minimizing bundle of labor and capital given by point A. The current price of output is $30. CAPITAL NsOogst1 Isocost2 LO IQ (Q=800) 19(Q=400) IQ (Q=150) LABOR Now suppose the price of output falls from $30 to $20, shifting the isocost curve from Isocost1 to Isocost2. This will induce firms to production in both the short run and the long run. In the short run, the firm will choose the input bundle indicated by point , whereas in the long run, it will move to point

Answer 1

When price of output falls from $30 to $20, isocost shifts from isocost1 to isocost2. This will induce firms to decrease production in both short run and long run. In short run, the firm will choose input bundle at point B, in long run, it will move to point D.

This is because when price falls, quantity supplied falls because of the positive relationship between price and quantity supplied (law of supply). Hence, firms will decrease production both in short run and in long run. Further, in the short run, when firm tries to decrease production, it can only do so by decreasing the amount of labour employed; capital is fixed in short run, so firm can't decrease capital. Therefore, in short run, firm will move to point B which has same level of capital but a lower level of labour than point A. So, firm will operate on the isoquant, q=400 in short run. In the long run, both labour and capital are flexible, so firm can decrease both capital and labour. It will move to the tangency point of isocost2 and the isoquant, q=150, given by D.

PRICE SR Supply $30 LR Supply $20 0 100 200 300 400 500 600 700 800 900 1000 QUANTITY SUPPLIED Help Clear All

Long run supply curve is more elastic than short run supply curve- True This can be directly seen from the figure (long run curve is flatter as compared to short run curve). Long run supply is more elastic than short run because both capital and labour are flexible in the long run, whereas in short run, only labour is flexible, capital is constant. Hence, as we already saw in the previous question, if there is a change in price, in the long run quantity supplied will change by more than the short run quantity supplied.