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Long Run versus Short Run

Long Run versus Short Run

What It Means

In analyzing decisions that businesses make, economists talk about two different time frames: the short run and the long run. These terms do not correspond to literal periods of time, such as two months or two years; instead, they are defined according to the range of options a business has for changing its output, or the final items it produces for sale. In the eyes of economists, a business can change its output by making alterations to inputs, the various ingredients required to produce whatever it is that a given company produces. Inputs (often called the factors of production) include land and natural resources, labor, and capital (equipment needed to do business). The short run is the period during which some inputs are fixed and unchangeable, while others are variable. The long run is the period during which all inputs are variable.

For example, imagine a company, Best Bats, that makes wooden baseball bats. In the short run, Best Bats has fixed as well as variable inputs. One fixed input is the size of its factory and machines. One variable input is the size of its labor force. The quantity of bats the company can produce is constrained by the fixed size of the factory and machines, but within the limits imposed by these fixed inputs, Best Bats does have some flexibility to increase output by increasing the number of its workers or the hours they work.

In the long run, by contrast, all inputs are variable. Best Bats can alter its workforce to meet any variety of business demands, and it can also build new factories and purchase new machinery. Additionally, new bat manufacturers can build factories and enter the market in the long run.

The length of the short run, and the moment at which it gives way to the long run, would be defined by the length of time it takes Best Bats (or a new company) to build the factory and install the new machinery. Accordingly, the duration of the short run differs from industry to industry, company to company, and situation to situation.

When Did It Begin

The concepts of the short run and the long run, as they are understood today, were popularized by the British economist Alfred Marshall (1842–1924), whose Principles of Economics was the standard economics textbook for decades after its first publication in 1890. Marshall was one of the first economists to grasp fully the importance of time in the interaction between supply (the quantity of a good that sellers are willing to sell over a range of prices) and demand (the quantity of a good that buyers are willing to buy over a range of prices). Prices are always dependent on supply and demand; these competing forces balance one another out, theoretically, at an equilibrium price that is acceptable to both sellers and buyers. Marshall’s contribution was to point out that the equilibrium price for any good was different depending on the time conditions of the buying and selling. In the short term, a diamond merchant and his customers might bargain over a set number of diamonds (the ones he had with him at that moment), arriving at an equilibrium price based on the fact that the supply was clearly limited. Over the long term, however, the merchant or his employers could open more diamond mines if consumer demand warranted it. This change in the level of supply would change the equilibrium price for diamonds.

More Detailed Information

To understand the variable nature of the time periods represented by the terms short run and long run, consider the contrast between our bat manufacturer, Best Bats, and a hot-dog vendor, Sally. Say that Best Bats produces 5,000 bats a day between the hours of nine o’clock in the morning and five o’clock in the afternoon, utilizing a 10,000 square-foot factory and a workforce of 50 men and women. If Best Bats begins getting orders from sporting goods stores that require it to produce 10,000 bats per day, in the short run it has some options but not others. It cannot satisfy these orders immediately by building a new factory. It might, however, quickly develop the capability to fill these orders if it hires 50 new workers to work a late shift, after the other 50 have gone home. If Best Bats’ orders begin to outpace even these increases, its owners might decide to invest in a new factory. A 10,000 square-foot factory might take as long as a year to build. In the case of Best Bats, then, the duration of the short run would be one year, and long run would be any amount of time greater than one year.

Sally, meanwhile, rents her hot-dog cart on a daily basis and then wheels it out into the city streets and tries to sell out of her supply of 500 hot dogs. Say that Sally consistently sells out of her hot dogs after eight hours at her cart, and that she decides she wants to try and sell more hot dogs in a day. She can return to the cart-supplier’s warehouse tomorrow with her little sister Sheila in tow, rent out a cart and purchase hot dogs for Sheila to sell, and expand her operation immediately. In this case, the short run lasts less than one day. Long-run changes in inputs are those that require at least one day to take effect.

In the short run businesses are susceptible to the law of diminishing returns. This law states that as additional units of a variable factor (such as labor) is added to a fixed factor (such as capital), productivity will decrease beyond a certain point. For example, if Best Bats tries to increase production of bats not only by adding a night shift of workers but by doubling the number of workers that operate the factory equipment at any given time, the law of diminishing returns may come into play. It may be that the bat factory’s machines cannot be efficiently operated by more than 75 people. Once there are more than 75 people on the factory floor, some amount of the workforce is not doing efficient work. People stand around without anything to do because there is no room for them at the machinery. They might even get in the way of those who are otherwise able to do productive work. Best Bats has doubled the amount of money it is spending on the variable input of labor, but it is not doubling its output of bats.

When considering long-run changes to such inputs as capital, a company seeks to take advantage of what economists call economies of scale. As a company produces more and more units of a good, it has numerous opportunities to cut its input costs per unit. Thus, Best Bats might build a new factory that doubles the amount of money it spends on inputs, but it might be able to produce and sell more than double the amount of bats as a result. This is because there are various ways of cutting costs open to large-scale producers that are not available to smaller-scale producers. Economies of scale, as these ways of cutting costs are called, do not inevitably result from expansion, however. It is possible that a business could make long-run changes to capital and labor that yield a result that is roughly proportionate to its previous level of output. It is also possible that the business’s efficiency could suffer as a result of expansion. In this case, a diseconomy of scale would be present.

Recent Trends

The concepts of the short run and the long run have remained constant over time. Companies today make short-run and long-run decisions much in the way that they did in the late nineteenth or early twentieth century. For example, Best Bats’ capital inputs (factory size and machinery) would have been fixed in the short run in 2007 no less than in 1907, and its labor inputs would have been similarly variable regardless of the historical context. However, the length of the short run likely would have varied considerably during these periods due to such factors as technology. In 1907 it might have taken three years to build a new factory with the technologies then available, whereas it may only have taken one year in 2007. Likewise, a business would have been able to hire, fire, or otherwise alter its labor inputs in both eras, but in 2007 the company may have been subject to greater government restrictions in this regard, though not to the degree that its labor input had become fixed. Thus, the scope of short- and long-run decisions may change over time, but the basic principles remain the same.

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