Like any other unit, a firm is also limited by the technology available. Thus, it can increase its outputs only by increasing its inputs. As usual, this will be expressed by a production function. The output that a firm can produce depends on the land, labor and capital the firm puts to work.
In formulating the neoclassical theory of a firm, John Bates Clark took over the classical categories of land, labor and capital and simplified them in two ways. These are as follows:
1. He assumed that all labor is homogenous-- One labor hour is a perfect substitute for any other labor hour.
2. He ignored the distinction between land and capital, grouping together both kinds of non-human inputs under the general term “capital.” And he assumed that this broadened “capital” is homogenous.
Ofcourse, the simplifying assumptions are not true. John Bates Clark’s conception of a firm is highly simplified, like a map at a very large scale. In more advanced economics, one can get rid of the simplifying assumptions and deal with a much more realistic “map” of a business firm.
In the John Bates Clark model, there are some important differences between labor and capital and they relate to the long and short-run.
Short and Long-Run
A key distinction between the short and long-run is as follows:
Some inputs can be varied flexibly in a relatively short period of time. One conventionally thinks of labor and raw materials as “variable inputs” in this sense. Other inputs require a commitment over a longer period of time. Capital goods are thought of as “fixed inputs” in this sense. A capital good represents a relatively large expenditure at a particular time with the expectation that the investment will be repaid and any profit paid
by producing goods and services for sale over the useful life of the capital good. In this sense, a capital investment is a long-term commitment. So, capital is thought of as being variable only in the long-run but fixed in the short-run.
Thus, one can distinguish between the short-run and the long-run as follows:
In the perspective of the short-run, the number and equipment of firms operating in each industry is fixed. In the perspective of the long-run, all inputs are variable and firms can come into existence or cease to exist. So, the number of firms is also variable.
In formulating the neoclassical theory of a firm, John Bates Clark took over the classical categories of land, labor and capital and simplified them in two ways. These are as follows:
1. He assumed that all labor is homogenous-- One labor hour is a perfect substitute for any other labor hour.
2. He ignored the distinction between land and capital, grouping together both kinds of non-human inputs under the general term “capital.” And he assumed that this broadened “capital” is homogenous.
Ofcourse, the simplifying assumptions are not true. John Bates Clark’s conception of a firm is highly simplified, like a map at a very large scale. In more advanced economics, one can get rid of the simplifying assumptions and deal with a much more realistic “map” of a business firm.
In the John Bates Clark model, there are some important differences between labor and capital and they relate to the long and short-run.
Short and Long-Run
A key distinction between the short and long-run is as follows:
Some inputs can be varied flexibly in a relatively short period of time. One conventionally thinks of labor and raw materials as “variable inputs” in this sense. Other inputs require a commitment over a longer period of time. Capital goods are thought of as “fixed inputs” in this sense. A capital good represents a relatively large expenditure at a particular time with the expectation that the investment will be repaid and any profit paid
by producing goods and services for sale over the useful life of the capital good. In this sense, a capital investment is a long-term commitment. So, capital is thought of as being variable only in the long-run but fixed in the short-run.
Thus, one can distinguish between the short-run and the long-run as follows:
In the perspective of the short-run, the number and equipment of firms operating in each industry is fixed. In the perspective of the long-run, all inputs are variable and firms can come into existence or cease to exist. So, the number of firms is also variable.
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