XIX. THE SHORT RUN AND THE LONG RUN

(This section was written by Roger Adkins at Marshall University for his principles of microeconomics classes and is used with his permission.)

In order to better understand how economic units such as the firm adjust to changing circumstances, economists have several analytical time periods. These are the short‑run (SR) and the long‑run (LR). In microeconomics these periods are unrelated to calendar time; in other words, we do not say the SR is six months or nine months or a year, and the LR is then greater period of time. Rather, the SR and LR are defined in terms of how it takes certain types of adjustments to occur.

We can think of these as planning periods or planning horizons. Some of our plans involve the here and now, immediate or tactical plans. Some of our plans deal with decisions that will affect things for a long time to come, strategic plans. Strategic plans are long-run plans, where as tactical plans are short-run plans.

The firm has two types of resources (inputs) for producing a good or service they are either fixed or variable. A fixed resource would be the buildings and equipment (machinery) of the firm. Examples of variable resources are labor, raw materials, and energy. The firm can easily expand production by quickly adding more or the variable resources, or the use of these inputs can be reduced with a drop in output. The firm can control the amount of variable resources used. Suppose the demand for the firm's product were to surge beyond the capacity of the firm's production facilities. How would the firm respond? While the firm can readily increase the amount of its variable inputs as demand expands it is unable to add to an existing structure or to put up a new building or to put in new equipment without the passage of some amount of time. A new firm seeking to enter this industry in response to the higher level of demand (and presumably higher profits) will also require time to build the new structures and install the equipment. We define the LR as the period of time it takes for an existing firm to expand capacity and/or for a new firm to enter the industry. (The LR is also the time it takes for an existing firm to expand capacity and/or for a new firm to enter the industry. (The LR is also the time it takes for an existing firm to reduce its capacity in response to lower demand or for that firm to leave the industry.)

In the LR the firms can vary the levels of all resources; this is an alternative definition. The firm looks to some time in the future and concludes that they can sell this amount of output which will require this size plant using this amount of labor. If the forecast is changed, the firm will chose a different size plant and a different level of employment. All resources are variable.

The SR is the length of time in which the response of the firm to changes in the market is limited. The fixed input(s) cannot be altered. The firm is free to add of reduce the amount of variable resources as the market dictates. So the SR is that period of time in which the firm has at least one fixed factor of production and one or more variable inputs. The consequence is that any drastic change in the market will be met by a limited response in the SR since only variable resources can be altered. But in the LR, a fuller response will occur because the firm will be free to change all inputs.