Which is longer, the short run or the long run?

Journal of Economics and Economic Education Research, Sept, 2003 by William L. Holahan, Mark C. Schug

ABSTRACT

This paper focuses on a common oversimplification in the presentation of one of the most basic concepts that we teach: the distinction between short run and long run in the theory of production. This paper illustrates how the terms "long run" and "short run" do not mean the same thing in demand and supply analysis they mean in the theory of production. In supply and demand analysis, short run and long run refer to the length of periods of chronological time. In the theory of production, the short run and long run refer to how time is used, not how much time is used. The long run refers to the planning process while the short run refers to operations. A survey of commonly available principles of economics textbooks reveals that this conceptual difference is not being taught.

Albert Einstein instructed us to explain the complex as simply as possible, but no simpler. Oversimplification will at the very least rob a subject of richness, and at worst mislead. Economics is based upon simplifying assumptions, and part of the science is the avoidance of misleading oversimplification. The purpose of this paper is to point out a common oversimplification in the principles of economics course, involving one of the most basic concepts that we teach: the distinction between short run and long run in the theory of the firm. The common definitions of these terms are so well accepted that a survey of available texts shows uniformity in the use of the overly simple definition. We then offer a simple way to resolve the issue with an explanation that clears up the potential for confusion, is economically correct, and is intellectually fun.

HOW THE "LONG RUN" AND "SHORT RUN" DIFFERS IN SUPPLY AND DEMAND VERSUS THE THEORY OF PRODUCTION

The basic problem is that the terms "long run" and "short run" do not mean the same in demand and supply analysis as they mean in the theory of the firm. Unfortunately, none of the textbooks book we examined points this out. In supply and demand analysis, short run and long run refer to the length of periods of chronological time. In the theory of the firm, the short run and long run refer to how time is used as a resource, not how much time is used. In the long run firms plan; in the short run they operate the facility that they decided to install during their planning.

Our examination of widely available principles texts (see Table 1) reveals that in supply and demand analysis, authors correctly explain that demand is more elastic in the long run than in the short run because decision makers have more time to adjust to changes in prices. Similarly on the supply side, supply is more elastic in the long run than in the short run, again, because decision makers have more time to adjust. So, we give the students the clear and correct instruction that we are referring to the length of periods of chronological time.

Without proper explanation, students naturally think that the terms "long run" and "short run" in the theory of the firm are once again referring to chronological time as was the case in supply and demand analysis. In fact, many texts appear to reinforce misunderstanding when they explain that the short run is a period so short that only the variable factors of production can be varied as is the case in the standard Q = F (K,L) total product function, when only L can be varied in the short run. The implication is that K cannot be varied because there isn't enough time.

A FIRM CAN BE SIMULTANEOUSLY IN THE LONG RUN AND THE SHORT RUN

Two Ironies Flow from this Discussion

First, the long run can occupy a much shorter period of chronological time than the short run. An example that is both familiar and instructive is McDonalds. All students have been in a McDonalds restaurant, many of them hundreds of times. They can see the capital and the labor in a short run setting. They cannot see the long run planning, but that can be described: To establish a new McDonald's franchise, the franchisee works with planners from corporate headquarters to estimate demand, and, in turn, the size, shape and equipment that will maximize profits for the firm. The planning stage is the long run. Prior to installation, no hamburgers are being flipped when people are planning. Only when the best assortment of capital is chosen and installed can labor be applied to its operation.

The operation of the installed capacity takes place in the short run. A typical McDonalds can be planned, built, and ready for operation in a matter of a few months, and operated for many years. That is, the short run operating period is a much longer period of chronological time than the long run planning period. In fact, the better the long run planning decisions, the longer the short run will last.

Second, a firm can be in the long run and the short run at the same point in time. How can this be? Firms typically have operating divisions and planning divisions working at the same time. Operating divisions work in the short run as they produce goods and services. At the same time, across the hall or across the world, others in the firm are working in the long run. These are the planners who are deciding what changes are to be made to capital and how labor is to be deployed in the future. Not only can the long run and the short run take place at the same time, the long run can precede or succeed the short run. For example, the long run must precede the short run in the installation of a new McDonalds, then after the short run has expired and the restaurant goes out of the fast food business, the planners must return to determine how the land and building will be used in future, a long run exercise that may not take much chronological time.