The Short Run Versus the Long Run in Economics

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In economics, it's extremely important to understand the distinction between the short run and the long run. As it turns out, the definition of the short run versus the long run differs depending on whether the terms are being used in a microeconomic or a macroeconomic context. There are even different ways of thinking about the microeconomic distinction between the short run and the long run.

 

The Short Run Versus The Long Run in Production Decisions

The long run is not defined as a specific period of time, but is instead defined as the time horizon needed for a producer to have flexibility over all relevant production decisions.

Most businesses make decisions not only about how many workers to employ at any given point in time (i.e. the amount of labor) but also about what scale of an operation (i.e. size of factory, office, etc.) to put together and what production processes to use. Therefore, the long run is defined as the time horizon necessary to not only change the number of workers but also to scale the size of the factory up or down and alter production processes as desired.

In contrast, economists often define the short run as the time horizon over which the scale of operation is fixed and the only available business decision is the number of workers to employ. (Technically, the short run could also represent a situation where the amount of labor is fixed and the amount of capital is variable, but this is fairly uncommon.)  The logic is that, even taking various labor laws as given, it's usually easier to hire and fire workers than it is to significantly change a major production process or move to a new size of factory or office.

(One reason for this likely has to do with long-term leases and such.) As such, the short run and the long run with respect to production decisions can be summarized as follows:

 

  • Short run: Quantity of labor is variable but quantity of capital and production processes are fixed (i.e. taken as given)
  • Long run: Quantity of labor, quantity of capital, and production processes are all variable (i.e. changeable)

 

The Short Run Versus The Long Run in Measuring Costs

Sometimes the long run but is defined as the time horizon over which there are no sunk fixed costs. In general, fixed costs are costs that don't change as production quantity changes. In addition, sunk costs are those costs to a business that can't be recovered after they are paid. Therefore, a lease on a corporate headquarters would be a sunk cost, for example, if the businesses has to sign a lease for the office space and can't break the lease or sublet, and it would be a fixed cost because, after a scale of operation is decided on, it's not as though the company needs some incremental additional unit of headquarters for each additional unit of output it produces.

Obviously the company would likely need a larger headquarters if it decided to expand a lot, but this scenario refers to the long-run decision of choosing a scale of production. Therefore, there are no truly fixed costs in the long run, since, in the long run, the firm is free to choose the scale of operation that determines at what level the fixed costs are fixed.

In addition, there are no sunk costs in the long run, since the company has the option of not doing business at all and incurring a cost of zero.

In summary, the short run and the long run in terms of cost can be summarized as follows:

 

  • Short run: Fixed costs are already paid and are unrecoverable (i.e. "sunk")
  • Long run: Fixed costs have yet to be decided on and paid, and are thus not truly "fixed"

The two definitions of the short run and the long run so far are really just two ways of saying the same thing, since a firm doesn't incur any fixed costs until it chooses a quantity of capital (i.e. scale of production) and a production process.

The Short Run Versus The Long Run in Market Entry and Exit

Continuing the preceding cost logic, we can define the short run versus the long tun in terms of market dynamics. In the short run, firms have already chosen whether to be in business and at what scale and technology of production. As such, the number of firms in an industry is fixed in the short run, and the firms in the market are just deciding how much, if anything, to produce. In the long run, firms have the flexibility to fully enter or exit an industry, since they can choose whether or not to incur or renew the up-front fixed costs of getting into or staying in an industry in the long run.

We can differentiate between the short run and the long run with regard to market dynamics as follows:

  • Short run: The number of firms in an industry is fixed (even though firms can "shut down" and produce a quantity of zero)
  • Long run: The number of firms in an industry is variable since firms can enter and exit

Microeconomic Implications of the Short Run Versus the Long Run

The distinction between the short run and the long run has a number of implications for differences in market behavior, which can be summarized as follows:

The Short Run:

The Long Run:

    The distinction between the short run and the long run is also important to understand from a macroeconomic perspective. In macroeconomics, the short run is generally defined as the time horizon over which the wages and prices of other inputs to production are "sticky," or inflexible, and the long run is defined as the period of time over which these input prices have time to adjust. The reasoning is that output prices (i.e. stuff sold to consumers) are more flexible than input prices (i.e. prices of stuff used to make more stuff) because the latter is more constrained by long-term contracts and social factors and such.

    In particular, wages are thought to be especially sticky in a downward direction since workers tend to get very upset when an employer tries to reduce their wages, even when general deflation in the economy is present and the stuff that the workers buy is getting cheaper as well.

    The distinction between the short run and the long run in macroeconomics is important because many macroeconomic models conclude that the tools of monetary and fiscal policy have real effects on the economy (i.e. affect production and employment) only in the short run and, in the long run, only affect nominal variables such as prices and nominal interest rates and have no effect on real economic quantities.