A business cannot determine whether its production is short term or long term without analyzing several factors. Total product is the comprehensive output generated by all of the business's methods of production. Labor- and manufacturing-based industries can easily determine total product by measuring the volume of production, labor and capital input together. Knowledge-based industries measure total output by measuring "intangible" factors such as patents, intellectual property and knowledge. Average product divides the total product by the number of employees, units or machines involved in producing the goods. Marginal product measures the changes in the total product that occur by adding a variable function that affects production, such as new employees, more raw materials or additional machines.
The short run refers to a period of time in which a business cannot change all of the production factors listed in Step 1. Instead, one or more of the factors will remained fixed, and cannot be manipulated. In many industries, the short-run period occurs because the business handles production on a fixed area of land and/or capital, using a set amount of machines. Should the business add more labor or raw materials to the fixed land, diminishing returns will occur. The total output will rise at first, then begin to gradually decrease, due to the increase in marginal product.
In the long run, all three production factors can be manipulated. Because each factor is variable, any changes to input (such as employees, machines and units of capital) and total output are called returns to scale. A business experiences increasing returns when the percentage change in total output is more than the change in inputs. For example, a business has increasing returns if it only increases its employees and raw materials by 50 percent, but experiences a total output increase of 88 percent. In decreasing returns, a business's percentage change in total output is less than the change in inputs. Constant returns happen when the input and output remain the same.
There is no specific time length for long- or short-run production. However, a business usually makes short-run decisions after creating long-run plans. Both long-run and short-run plans experience marginal physical product, or MPP. MPP outlines the change in total output that occurs after hiring one additional employee. Marginal product of labor occurs in the short run, and is similar to MPP. With fixed capital, marginal product of labor displays the increased total output that occurs after the employee is hired.