Explain how the permanent income hypothesis reconciles the difference between short-run and long-run consumption behavior.

• All production in real time occurs in the short-run. The decisions made by businesses tend to be focused on operational aspects, which is defined as specific decisions made to manage the day to day activities in the company. Businesses are limited by many things including staff, facilities, skill-sets, and technology. Hence, decisions reflect ways to achieve maximum output given these restrictions. In the short-run, increases and decreases in variable factors are the only things that can affect the output produced by firms. They could change things such as labour and raw materials. They are not able to change fixed factors such as buildings, rent, and know-how since they are in the early stages of production.

Firms make decisions with respect to costs. In the short-run, the variation in output, given the current level of personnel and equipment, determines the costs along with fixed factors that are unavoidable in the early stages of the firm. Therefore, costs are both fixed and variable. A standard way of viewing these costs is per unit, or the average. Economists tend to analyse three costs in the short-run: average fixed costs, average variable costs, and average total costs, with respect to marginal costs.

The average fixed cost curve is a decreasing function because the level of fixed costs remains constant as the output produced increases. Both the average variable cost and average total cost curves initially decrease, then start to increase. The more variable costs used to increase production (and hence more total costs since TC=FC+VC), the more output generated. Marginal ___ _____ ___ ________ ____.
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