Long run and short run

The differentiation between long-run and short-run economic models did not come into practice until 1890, with Alfred Marshall's publication of his work Principles of Economics. However, there is no hard and fast definition as to what is classified as "long" or "short" and mostly relies on the economic perspective being taken. Marshall's original introduction of long-run and short-run economics reflected the ‘long-period method’ that was a common analysis used by classical political economists. However, early in the 1930s, dissatisfaction with a variety of the conclusions of Marshall's original theory led to methods of analysis and introduction of equilibrium notions. Classical political economists, neoclassical economists, Keynesian economists all have slightly different interpretations and explanations as to how short-run and long-run equilibriums are defined, reached, and what factors influence them.[3]

Since its origin, the "long period method" has been used to determine how production, distribution and accumulation take place within the economy. In a long run, firms change production levels in response to (expected) economic profits or losses, and the land, labour, capital goods and entrepreneurship vary to reach the minimum level of long-run average cost. In the simplified case of plant capacity as the only fixed factor, a generic firm can make these changes in the long run:

• enter an industry in response to (expected) profits
• leave an industry in response to losses
• increase its plant in response to profits
• decrease its plant in response to losses

The long run is associated with the long-run average cost (LRAC) curve in microeconomic models along which a firm would minimize its average cost (cost per unit) for each respective long-run quantity of output. Long-run marginal cost (LRMC) is the added cost of providing an additional unit of service or commodity from changing capacity level to reach the lowest cost associated with that extra output. LRMC equalling price is efficient as to resource allocation in the long run. The concept of long-run cost is also used in determining whether the firm will remain in the industry or shut down production there. In long-run equilibrium of an industry in which perfect competition prevails, the LRMC = LRAC at the minimum LRAC and associated output. The shape of the long-run marginal and average costs curves is influenced by the type of returns to scale.

The long run is a planning and implementation stage.[4][5] Here a firm may decide that it needs to produce on a larger scale by building a new plant or adding a production line. The firm may decide that new technology should be incorporated into its production process. The firm thus considers all its long-run production options and selects the optimal combination of inputs and technology for its long-run purposes.[6] The optimal combination of inputs is the least-cost combination of inputs for desired level of output when all inputs are variable.[5] Once the decisions are made and implemented and production begins, the firm is operating in the short run with fixed and variable inputs.[5][7] . Another part of the development of planning what a firm may decide if it needs to produce more on a larger scale or not is Keynes theory that the level of employment(labor), oscillates over an average or intermediate period, the equilibrium. This level of fixed capital is determined by the effective demand of a good. Changes in the economy, based on capital, variable and fixed cost can be studied by comparing the long run equilibrium to before and after changes in the economy.

All production in real time occurs in the short run. In the short run, a profit-maximizing firm will:

• increase production if marginal cost is less than marginal revenue (added revenue per additional unit of output);
• decrease production if marginal cost is greater than marginal revenue;
• continue producing if average variable cost is less than price per unit, even if average total cost is greater than price;
• shut down if average variable cost is greater than price at each level of outputs

The transition from the short run to the long run may be done by considering some short-run equilibrium that is also a long-run equilibrium as to supply and demand, then comparing that state against a new short-run and long-run equilibrium state from a change that disturbs equilibrium, say in the sales-tax rate, tracing out the short-run adjustment first, then the long-run adjustment. Each is an example of comparative statics. Alfred Marshall (1890) pioneered in comparative-static period analysis.[8] He distinguished between the temporary or market period (with output fixed), the short period, and the long period. "Classic" contemporary graphical and formal treatments include those of Jacob Viner (1931),[9] John Hicks (1939),[10] and Paul Samuelson (1947).[11][12] The law is related to a positive slope of the short-run marginal-cost curve.[13]

The usage of long run and short run in macroeconomics differs somewhat from the above microeconomic usage. John Maynard Keynes in 1936 emphasized fundamental factors of a market economy that might result in prolonged periods away from full-employment.[14][15] In later macroeconomic usage, the long run is the period in which the price level for the overall economy is completely flexible as to shifts in aggregate demand and aggregate supply. In addition there is full mobility of labor and capital between sectors of the economy and full capital mobility between nations. In the short run none of these conditions need fully hold. The price level is sticky or fixed in response to changes in aggregate demand or supply, capital is not fully mobile between sectors, and capital is not fully mobile across countries due to interest rate differences among countries and fixed exchange rates.[16]

A famous critique of neglecting short-run analysis was by Keynes, who wrote that "In the long run, we are all dead", referring to the long-run proposition of the quantity theory of money, for example, a doubling of the money supply doubling the price level.[17]

• Cost curve (including long-run and short-run cost curves)

• Armen, Alchian, 1959. "Costs and Outputs," in M. Abramovitz, ed., The Allocation of Economic Resources, ch. 2, pp. 23-40. Stanford University Press. Abstract.
  • Hirshleifer, Jack, 1962. "The Firm's Cost Function: A Successful Reconstruction?" Journal of Business, 35(3), pp. 235-255.
• Boyes, W., 2004. The New Managerial Economics, Houghton Mifflin. ISBN 0-395-82835-X
• Melvin & Boyes, 2002. Microeconomics, 5th ed. Houghton Mifflin.
• Panico, Carlo, and Fabio Petri, 2008. "long run and short run," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.
• Perloff, J, 2008. Microeconomics Theory & Applications with Calculus. Pearson. ISBN 978-0-321-27794-7
• Pindyck, R., & D. Rubinfeld, 2001. Microeconomics, 5th ed. Prentice-Hall. ISBN 0-13-019673-8
• Viner, Jacob, 1940. "The Short View and the Long in Economic Policy," American Economic Review, 30(1), Part 1, pp. 1-15. Reprinted in Viner, 1958, and R. B. Emmett, ed. 2002, The Chicago Tradition in Economics, 1892-1945, Routledge, v. 6, pp. 327- 41. Review extract.
• Viner, Jacob, 1958. The Long View and the Short: Studies in Economic Theory and Policy. Glencoe, Ill.: Free Press.