What Is the Short Run?
Short run is an economic concept that states that, within a certain period in the future, at least one input is fixed while others are variable. It expresses the idea that an economy behaves differently depending on the length of time it has to react to certain stimuli. The short run does not refer to a specific duration of time but ratheris unique to the firm, industry or economic variable being studied.
Key Takeaways
- The short run, as it applies to business, states that at a certain point in the future, one or more inputs will be fixed, while others are variable.
- When it relates to economics, the short run speaks to the idea that an economy's behavior will vary based on how much time it has to absorb and react to stimuli.
- The short run's counterpart is the long run, which contains no fixed costs. Instead, costs balance out with the desired amount of costs available at the lowest possible price.
- In the short run, profit is maximized when marginal revenue exceeds marginal cost.
Understanding the Short Run
The short run as a constraint differs from the long run. In the short run, leases, contracts, and wage agreements limit a firm's ability to adjust production or wages to maintain a rate of profit. In the long run, there are no fixed costs; costs find balance when the combination of outputs that a firm puts forth results in the sought after amount of the goods at the cheapest possible price.
If a hospital experiences lower than expected demand in a given year, but its entire employment force of doctors, nurses, and technicians is under contract for the year, then the hospital has no choice but to swallow a cut in its profit. In the long run, firms in capital-intensive industries, such as oil and mining, have time to expand or shrink operations in factories or investments in correspondence with changing demand. But in the short run, they are unable to capitalize on changes in demand with the same degree of flexibility.
The short run does not refer to a specific period of time and is instead specific to the firm, industry or economic factor being studied.
Short Run Decision-Making
The primary objective of the short run is to determine the level of production that maximizes profit or minimizes losses given the current constraints. One related concept is marginal analysis. Firms evaluate the marginal product of each variable input, which is the additional output generated by employing one more unit of that input. Initially, as more variable inputs are added, the marginal product tends to increase due to better utilization of fixed inputs. However, due to the law of diminishing marginal returns, the marginal product eventually decreases as more units of the variable input are added. Firms aim to balance the input levels where the cost of an additional input equals the revenue generated from the additional output it produces.
Cost considerations also play a role in short-run production decisions. Firms categorize costs into fixed costs, which remain constant regardless of output level, and variable costs, which change with the level of production. By analyzing average and marginal costs, firms can determine the most cost-effective production level. The marginal cost, which is the additional cost of producing one more unit of output, is particularly important.
In the short run, external factors such as market demand and input prices also influence production decisions. Firms must respond to changes in demand by adjusting their output levels to maintain profitability. For instance, an increase in demand may prompt a firm to temporarily increase production by hiring more labor or utilizing existing resources more intensively. This could happen around the holiday season, for example. Input prices can also impact production decisions; rising input costs may force firms to find more efficient production methods or pass the increased costs onto consumers through higher prices.
Firms seek to produce at the output level where marginal cost equals marginal revenue, as this maximizes profit.
Limitations of Short Run Strategies
The short run in economics has several limitations, primarily due to the presence of fixed inputs and the constraints they impose on production flexibility. Here's a short list of those downsides:
Fixed Inputs
In the short run, at least one input (such as capital or land) is fixed, meaning it cannot be adjusted to meet changes in production needs. This rigidity limits a firm's ability to respond swiftly to fluctuations in market demand or changes in input prices. That fixed variable may be unfavorable and the company may want to change it, but sometimes it simply can't because of market forces, contract obligations, or financial constraints.
Diminishing Marginal Returns
The law of diminishing marginal returns poses a significant limitation in the short run. As more units of a variable input are added to a fixed input, the additional output produced by each new unit eventually decreases. This diminishing productivity can lead to higher marginal costs and lower profitability as firms attempt to increase output. Eventually, a company may get to a point where its marginal expense costs more than its marginal revenue, meaning it's no longer profitable to make the good (at least in the short run).
Higher Operational Risk
The presence of fixed costs, such as rent, salaries, and equipment depreciation, in the short run means that these costs do not vary with the level of output. This rigidity can lead to financial strain if a firm experiences a sudden drop in demand or needs to scale down production. Fixed costs must be covered regardless of production levels, which can result in lower profit margins or even losses during periods of low output. This means in the short run, companies may experience a higher level of risk in regards to needing to make sure it has the sufficient cash flow to meet ongoing operational needs.
Short-Term Focus
The short run often forces firms to focus on immediate operational concerns rather than long-term strategic planning. Decisions are made to address short-term constraints and immediate profit maximization, potentially at the expense of long-term growth and innovation. This short-term focus can lead to underinvestment in research and development, employee training, and capital improvements. For example, if a company is perpetually having to toss employees into "emergency coverage situations", that company may not be building the skillset within those employees related to its long run target.
Short Run Vs. Long Run
The short run is characterized by at least one fixed input while other inputs are variable. Meanwhile, the long run is a period in which all inputs can be varied. Firms have the flexibility to adjust all factors of production including capital, labor, and technology. This means that firms can expand or contract their production or offerings in more flexible ways.
The long run is associated with the concept of returns to scale, which examines how changes in the scale of production affect output. In the long run, firms can achieve economies of scale, where increasing the scale of production leads to lower average costs, or diseconomies of scale, where increasing the scale results in higher average costs. In the short run (like we'll see at the end example with Delta Air Lines), the company is more interested in weathering short-term opportunities.
The distinction between the short run and the long run also affects market dynamics. In the short term, companies may experience periods of higher or lower profitability depending on short run strategies. This can fluctuate from period to period based on the market. In the long run, however, a company's profitability is perhaps less of a reflection on the industry and more on the firm's ability to adapt and change. For instance, Apple's strategy to manufacture Apple Vision Pro is a long run strategy that was implemented based on its interest in adapting to market conditions; the specific pricing strategy it may implement for its VR is a short run strategy.
Example of Short Run Costs
A real-world example of short-run decisions is the airline industry with a company like Delta. The airline industry has significant fixed costs, such as aircraft leases, maintenance, and airport gate rentals, which cannot be easily adjusted in the short run. However, Delta can make several variable adjustments to respond to market conditions:
- It Can Adjust Flight Schedules: In response to fluctuations in demand, Delta can alter its flight schedules. For instance, during periods of lower demand, such as the off-peak travel season, Delta might reduce the frequency of flights on certain routes or use smaller aircraft to reduce variable costs like fuel and crew expenses.
- It Can Offer Dynamic Pricing: Delta employs dynamic pricing strategies to optimize revenue. By adjusting ticket prices based on real-time demand and booking patterns, Delta can influence the load factor (percentage of seats filled) on its flights.
- It Can Adjust Labor Scheduling: Labor costs, including pilots, flight attendants, and ground staff, are significant variable costs for Delta. In the short run, the airline can adjust employee schedules to match the level of operational activity. For example, Delta might offer voluntary leave programs, adjust work shifts, or hire temporary staff during busy periods to ensure that labor costs align with current flight demand.
- It Can Hedge Fuel Costs: While fuel costs are a major variable expense, Delta uses fuel hedging strategies to mitigate the impact of fuel price volatility in the short run. By locking in fuel prices through options contracts, Delta can better predict its fuel expenses and manage costs more effectively, even if market prices fluctuate. Note that on a long enough timeframe, this may be considered a more broad, long-run strategy.
What Is the Definition of the Short Run in Economics?
The short run in economics refers to a period during which at least one input in the production process is fixed and cannot be changed. Typically, capital is considered the fixed input, while other inputs like labor and raw materials can be varied. This time frame is sufficient for firms to make some adjustments but not enough to alter all factors of production.
Why Are Some Costs Considered Fixed in the Short Run?
Fixed costs in the short run do not change with the level of output because they are associated with inputs that cannot be adjusted immediately. Examples include rent, salaries of permanent staff, and depreciation of capital equipment. These costs remain constant irrespective of production levels, leading to the classification as fixed.
How Is Short Run Profit Maximization Achieved?
Short run profit maximization is achieved by producing at the output level where marginal cost equals marginal revenue. Firms analyze the additional cost of producing one more unit (marginal cost) and compare it to the additional revenue generated (marginal revenue) to determine the most profitable production level.
How Do Changes in Demand Affect Firms in the Short Run?
Changes in demand affect firms in the short run by altering the equilibrium price and quantity in the market. Firms may respond by adjusting their variable inputs to match the new level of demand, but they are constrained by fixed inputs, which can limit their ability to scale production fully.
What Are Short Run Supply Curves?
Short run supply curves show the relationship between the price level and the quantity of goods that firms are willing to produce and sell, given fixed inputs. These curves typically slope upward, indicating that higher prices incentivize firms to increase production by adjusting variable inputs.
The Bottom Line
In economics, the short run denotes a period where at least one input is fixed, limiting a firm's ability to adjust its production capacity fully. During this phase, firms focus on optimizing variable inputs such as labor and materials to maximize output and profitability within the constraints of fixed costs.
