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Short Run

Short Run

BIBLIOGRAPHY

The term short run refers to a period of time in which at least one factor (input) of production cannot be immediately modified. This concept determines exactly how a firms decision-making is constrained. Factors of input may be constrained by past decisions or a decision that cannot immediately be implemented. The short run contrasts with the long run, in which all input factors that can be variable are variable. The short run does not specify any exact length of time, such as three months or one year. The short run can be five minutes or five years, depending on the exact characteristics of the fixed factors. Examples of circumstances that would place a firm in a short-run situation include but are not limited to: contracts that cannot be broken on rented machinery, the time required to build a bigger factory, rental agreements on factory space, the time required to purchase and assemble additional machinery, and the time required to find a renter for owned capital.

In the perfectly competitive model, the short run constrains firms to change only the amount of variable costs, typically the amount of labor employed. In the classic example, a firm can increase (decrease) production only by increasing (decreasing) its labor force. The amount of capital is fixed in the short run because the rental or purchase of large machinery and factory space requires long-term contracts that are not immediately revised. Contrasting this to the long run, labor is still variable, but now each individual firm has the option to purchase more capital or to not renew contracts and employ less capital.

In the short run, a firm will choose the level of variable inputs that maximizes its profit taking given its level of fixed inputs. The profit-maximizing output level may be chosen at zero, implying the short-run shutdown decision. In this case when the price at which a firm can sell its goods lies below the average variable costs of the firm, the firm would lose money on each additional unit of good that it produces, leaving it better off not to produce at all. A firm may not exit the industry in the short run, however, because of existing fixed costs. Once all fixed costs become variable, the firm has entered the long run, and is no longer in the short run. This gives the firm more opportunities to lower costs and increase profits by altering its inputs to achieve the most efficient production techniques. If the firm is unable to become profitable in the long run, it has the long-run option to exit the industry.

There are short-run and long-run versions of supply, demand, and the entire family of cost curves (marginal cost, average cost, total cost). It is important to recognize that in the short run, a firm has variable costs and fixed costs, represented by two separate curves. In the long run, all fixed costs become variable, eliminating the fixed cost curve and causing the variable cost and the total cost curves (and thus the corresponding average variable and average total cost curves) to collapse into one total cost and average cost curve. Typically, the short-run version of each curve is less elastic than its corresponding long-run version.

Jacob Viner presented these concepts in his 1931 work, Cost Curves and Supply Curves, which formalized the graphical and analytical analysis of short-run and long-run cost curves. This work is visible in the economics textbooks of the early twenty-first century as the graphical representations of markets and firms that are used to determine market equilibrium and firm behaviors.

In the field of macroeconomics, Milton Friedman (1912-2006) developed short-run and long-run concepts differentiated from one another with respect to expectations. In the short run, expectations about the future are not fully realized, and conversely in the long run, expectations are fully realized. For example, Edmund S. Phelps (b. 1933) and Friedman provide a distinction between the short-run and long-run Phillips curves. The Phillips curve, originally formulated by the New Zealand economist A. W. H. Phillips (1914-1975), displays the inverse relationship between unemployment and inflation. In the short run, expansionary monetary or fiscal policies will raise nominal wages as the demand for labor increases. These same policies will also have the effect of raising the overall price level, resulting in smaller real wage changes relative to the nominal wage change. Workers will eventually realize the inflationary effect on their real wages and insist on wage changes that keep pace with inflation. Those who entered the labor force because of higher nominal wages will exit once they realize that real wages are no higher than before the policy modification. The result is that in the short run, workers may supply more labor in response to expansionary policies in the absence of fully realized expectations, but in the long run, once expectations of price inflation have adjusted, unemployment will increase back to the previous natural level, while nominal prices and wages remain at their higher levels because of the original expansionary stimulus. This results in a deviation from the traditional Phillips curve, which Friedman refers to as the expectations-augmented Phillips curve. The faster the workers expectations are realized, the sooner the short run transitions into the long run, and the less effective expansionary policies will be.

In conclusion, the short run and the long run may be summarized as follows:

  • Short run: Some inputs variable, at least one fixed. Firms can choose a level of production only by changing the amount of a variable input. Choosing an output of zero implies the shutdown decision. New firms do not enter the industry, and existing firms do not exit. Supply, demand, and cost curves are less elastic (more inelastic).
  • Long run: All inputs variable, firms can enter and exit the marketplace. Supply, demand, and cost curves are more elastic.

SEE ALSO Long Period; Long Run; Phillips Curve; Short Period

BIBLIOGRAPHY

Baumol, William J., and Alan S. Blinder. 2006. Economics: Principles and Policy. 10th ed. Mason, OH: Thomson South-Western.

Black, John. 2002. A Dictionary of Economics. 2nd ed. Oxford: Oxford University Press.

Viner, Jacob. [1931] 1952. Cost Curves and Supply Curves. In Reading in Price Theory, eds. George J. Stigler and Kenneth E. Boulding, 198-226. Chicago: Richard D. Irwin.

Raymond A. Farkouh

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