Long run and short run
In economics, the long-run is a theoretical concept in which all markets are in equilibrium, and all prices and quantities have fully adjusted and are in equilibrium. The long-run contrasts with the short-run, in which there are some constraints and markets are not fully in equilibrium. More specifically, in
History
The differentiation between long-run and short-run economic models did not come into practice until 1890, with
Economic theory has employed the "long-period technique" of analysis to examine how production, distribution, and accumulation take place within a market economy ever since its first appearance in the writings of the 18th-century. According to classical political economists like Adam Smith, the "natural" or "average" rates of salaries, profits, and rent tend to become more uniform as a result of competition. Consequently, "market" prices, or observed prices, tend to gravitate toward their "natural" levels. In this case, according to the classical political economists, the divergence between a commodity's provide example of a commodity "market" and "natural" price is established by a disparity between the amount provided by producers and the "effective demand" for it. This gap between the "market" and "natural" price indicates that the commodity will likely experience windfall profits or losses. When the supply and the "effective demand" are in sync, the "market" price would end up corresponding to the "natural" price. The profit rate earned in that sector is the same as the profit rate earned across the whole economy, and it is stated that the conditions of equilibrium will prevail. Therefore, according to this specific approach, supply and demand changes only explain are indicative of the deviation that occur of "market" from "natural" prices.[4]
The "long-period technique" was once again implemented by the economists who later on developed the neoclassical theory. Unlike the classical political economics theory, the neoclassical economics theory set distribution, pricing, and output all at the same time. All of these variables' "natural" or "equilibrium" values relied heavily on technological conditions of production and were consequently linked to the "attainment of a uniform rate of profits in the economy."[5]
Long run
Since its origin, the "long period method" has been used to determine how production, distribution and accumulation take place within the economy. 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
- Add or reduce employees in response to profits/losses and firm requirements
The long-run is associated with the
The long-run is a planning and implementation stage.[6][7] 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.[8] The optimal combination of inputs is the least-cost combination of inputs for desired level of output when all inputs are variable.[7] Once the decisions are made and implemented and production begins, the firm is operating in the short-run with fixed and variable inputs.[7][9] 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.
In the long-run, consumers are better equipped to forecast their consumption preferences. They have ample time to make decisions, and therefore will act with a System 2 style of thinking which is more thought-out, planned, and rational. When consumers act this way, their utility and satisfaction improves.
Short run
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.[10] 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.
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 costs are the cost of producing one more unit of output. It is an increasing function due to the law of diminishing returns, which explains that is it more costly (in terms of labour and equipment) to produce more output.
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 decisions of the firm impacts consumer decisions. Since there are constraints in the short-run, consumers must make decisions in quick time with respect to their current level of wealth and level of knowledge.
Transition from short run to long run
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.[14] 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),[15] John Hicks (1939),[16] and Paul Samuelson (1947).[17][18] The law is related to a positive slope of the short-run marginal-cost curve.[19]
Macroeconomic usages
The usage of long-run and short-run in
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.[23]
Different Usages and Notion
The short-period equilibria' has been sometimes applied to post-Walrasian equilibria. On other occasions, Keynes's notion of equilibrium was mostly treated as temporary equilibrium. There were great differences between the post-Walrath model, Marshall model, and Keynes model. The post-Walrath model gives all capital goods, including mobile capital goods; Whereas in Marshall's short-term analysis, only the fixed factories of a single industry are a figure, in Keynes's work, only the fixed capital goods of the entire economy are given. The term ' long-period equilibrium' was often used to refer to post-Walrasian intertemporal equilibria with futures markets, sequences of temporary equilibria, and steady-growth equilibria. All these show huge ambiguity in the notion of equilibrium.
See also
- Cost curve (including long-run and short-run cost curves)
Notes
- ^ Paul A. Samuelson and William D. Nordhaus (2004). Economics, 18th ed., [end] Glossary of Terms, "Long run" and "Short run."
- ISBN 978-981-256-891-5.
- ^ Panico C., Petri F. (2008) Long Run and Short Run. Some of Marshall's original theories, adapted into new terminology and a variety of other analyses are some of the ways the long-run and short-run theories have been shaped. In: Palgrave Macmillan (eds) The New Palgrave Dictionary of Economics. Palgrave Macmillan, London
- ^ Smith, Adam (1776). An inquiry into the nature and causes of the wealth of nations. London: Methuen, 1904.
- ^ Panico, Carlo. "Long Run and Short Run". The New Palgrave Dictionary of Economics.
- ^ Melvin & Boyes, 2002. Microeconomics, 5th ed., p. 185. Houghton Mifflin.
- ^ a b c Boyes, W., 2004. The New Managerial Economics, p. 107. Houghton Mifflin.
- ^ Melvin & Boyes, 2002. Microeconomics, 5th ed., p. 185. Houghton Mifflin.
- ^ Perloff, J, 2008. Microeconomics Theory & Applications with Calculus, p. 230. Pearson .
- ^ Sharma, Abhi Dutt (22 April 2020). Managerial Economics (PDF). Meerut, India: NAS College. pp. 3–5. Retrieved 11 April 2021.
- ^ Sharma, Abhi Dutt (22 April 2020). Managerial Economics (PDF). Meerut, India: NAS College. pp. 3–5. Retrieved 11 April 2021.
- ^ Managerial Economics Principles (PDF) (v. 1.0 ed.). Creative Commons. 2019. pp. 47–55. Retrieved 11 April 2021.
- ^ Kahneman, Daniel (2011). Thinking Fast and Slow. New York: Farrar, Straus and Giroux.
- Principles of Economics, Macmillan.
- ^ Jacob Viner, 1931. "Costs Curves and Supply Curves," Zeitschrift für Nationalölkonomie (Journal of Economics), 3, pp. 23-46. Reprinted in R. B. Emmett, ed. 2002, The Chicago Tradition in Economics, 1892-1945, Routledge, v. 6, pp. 192- 215.
- ^ J.R. Hicks, 1939. Value and Capital: An Inquiry into Some Fundamental Principles of Economic Theory, Oxford.
- ^ Paul A. Samuelson, 1947. Foundations of Economic Analysis, Harvard University Press.
- ISBN 0-13-019673-8
- ^ While the law does not directly apply in the long-run it is not irrelevant. The long-run is the planning phase. A manager deciding which of several plants to build would want to know the shape of the SR cost curves associated with each of these plants. Marginal diminishing returns are related to the shape of the short-run marginal and average cost curves. Thus the law indirectly effects long-run decision making per R. Pindyck & D. Rubinfeld, 2001, Microeconomics, 5th ed., pp. 185-86. Prentice-Hall.
- ^ Carlo Panico and Fabio Petri, 2008. "long-run and short-run," Short- and long-period in Keynes, The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.
- ^ John Maynard Keynes, 1936. The General Theory of Employment, Interest and Money, pp. 4–5.
- ^ J. M. Keynes, 1923. A Tract on Monetary Reform, p. 65. Macmillan.
References
- 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, p p. 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.
“Equilibrium (Economics) - Explained.” The Business Professor, LLC, https://thebusinessprofessor.com/en_US/economic-analysis-monetary-policy/equilibrium-definition.