The Short Run and the Long Run

The Short Run and the Long Run

Before we examine how a firm chooses its output level and the costs it incurs, we must first understand the time horizon over which the firm can adjust its inputs. Economists divide time into two conceptual periods: the short run and the long run. These are not defined by calendar months or years; they are defined purely by whether all factors of production can be varied.

The Short Run

In the short run, at least one factor of production cannot be changed. That factor remains fixed. The firm can vary its output level only by changing the other factor(s). The factor that cannot be varied is called the fixed factor; the factor that can be varied is called the variable factor.

Consider a simple production process that uses two inputs: labour ($L$) and capital ($K$). In the short run, suppose capital is fixed at 4 units. The firm can produce different levels of output only by using different quantities of labour. The textbook illustrates this with Table 3.1 (reproduced conceptually below). With capital fixed at 4 units, the column for $K=4$ shows the output levels achievable with various amounts of labour.

The Long Run

In the long run, all factors of production can be varied. A firm can change both labour and capital simultaneously to produce different levels of output. There is no fixed factor in the long run.

Because different production processes have different adjustment times, the long run for one industry may be the short run for another. The only criterion is whether every input can be changed. If a firm can alter the quantity of every input it uses, it is operating in the long run.

Box: Isoquant

Just as indifference curves represent a consumer's preferences, isoquants represent a firm's production function. An isoquant is the set of all combinations of two inputs (say, labour $L$ and capital $K$) that yield the same maximum possible level of output. Each isoquant is labelled with the output level it represents.

Let us return to the textbook's Table 3.1. Notice that an output of 10 units can be produced in three different ways:

• 4 units of labour and 1 unit of capital $(4L, 1K)$
• 2 units of labour and 2 units of capital $(2L, 2K)$
• 1 unit of labour and 4 units of capital $(1L, 4K)$

All three combinations lie on the same isoquant, which represents the output level $q = 10$.