Short Run vs Long Run
In economics, short run refers to a period during which at least one of the factors of production (in most cases capital) is fixed. The long run, on the other hand, refers to a period in which all factors of production are variable.
Differentiation between short run and long run is important in economics because it tells companies what to do during different time periods. Let’s consider a company which is incurring losses. Assume that it needs at least one year to shut down operations. Despite the net loss, the company should continue producing during the short run (i.e. for one year) if its marginal revenue is higher than its marginal cost. It is because the company can’t move its capital to other uses instantaneously, so it should continue producing as long as each additional unit reduces the losses. However, if the marginal cost itself is higher than marginal revenue, it should cease to operate right away. The difference lies in the flexibility of the company to change different inputs.
Since the time it takes a firm to alter their inputs varies from the time it takes another firm, short run and long run represent different absolute time periods for different firms. A firm engaged in labor-intensive janitorial services may have quite a short long-run say 1 month because it can scale its operations up and down by hiring and firing employees and buying off-the-shelf equipment that it needs. On the other hand, an automaker has a very distant long-run because it takes it years to construct a new plant or dismantle it and relocate to some other location.
A factor of production that can be changed is called a variable factor and factor which can’t be adjusted is called a fixed factor. Generally, labor is the variable factor and capital is the fixed factor in the short run. On the other hand, both the labor and capital are the variable factors in the long-run.
Let’s consider a Skyler White’s A1A Car Wash. It operates for 12 hours a day, has three wash bays and 9 staff members each working 8 hours a day. A typical car wash takes 30 minutes. With these available resources, A1A Car Wash can accommodate 72 (=12 × 3 × 60/30) car washes.
A dusty storm swept through Albuquerque last night and there is a significant increase in number of motorists bringing their cars in for a wash. Skyler decides to extend operating hours from 12 to 15 by requiring each worker to work one additional hour at 1.5 times their regular wages. The extension in working hours enable A1A Car Wash to do 90 (15 × 3 × 60/30) car washes. This represent a short-term decision because the number of wash bays (i.e. capital) is constant because it can’t be changed over-night but the other factor of production i.e. labor can be adjusted right away.
Now, let’s assume that the municipal government recently discontinued certain bus routes catering to people living within 2 km radium of the car wash. It has resulted in a significant increase in number of cars owned by people living in the catchment area of the car wash. This structural change has resulted in increase in demand for car washes permanently. However, Skyler can’t cater to more than 90 motorists per day because (a) running the operations for 24 hours is not an option because people won’t bring their cars in for wash at odd times; and (b) the number of wash bays is a limiting factor which means that total car washes can’t be increased by just increasing the number of workers if there is no corresponding increase in number of wash bays. But constructing a wash bay takes at least months and it can’t be adjusted daily or weekly. The period in which A1A Car Wash or any other business can alter all its factors of production i.e. land, labor and capital, etc. is called long run.
by Obaidullah Jan, ACA, CFA and last modified on