Long-run

In economic models, the long-run time frame assumes no fixed factors of production. Firms can enter or leave the marketplace, and the cost (and availability) of land, labor, raw materials, and capital goods can be assumed to vary. In contrast, in the short-run time frame, certain factors are assumed to be file. This is related to the long run average cost (LRAC) curve, an important factor in microeconomic models.

A generic firm can make these changes in the long-run:

• Enter an industry
• Increase its plant
• Decrease its plant
• Leave an industry

Long run marginal cost (LRMC) refers to the cost of providing an additional unit of service or commodity under assumption that this requires investment in capacity expansion. LRMC pricing is appropriate for best resource allocation, but may lead to a mismatch between operating costs and revenues.

In long run equilibrium, the LRMC=Long run average total cost (LRATC) at the minimum of LRATC.

In macroeconomic models, the long run assumes full factor mobility between economic sectors, and often assumes full capital mobility between nations.

The concept of long run cost is used in cost-volume-profit analysis and product mix analysis.

A famous use of the phrase was by John Maynard Keynes, who said in dry humor, "In the long run, we are all dead."

All production occurs in the short run. The long run is a planning and implementation stage.^[1][2] During the long run a firm may decide that it needs to produce on a larger scale by building a new plant or adding a production line. The firm may decide that new technology should be incorporated into its production process. During the long run the firm considers all its short run production options and selects the optimal combination of inputs and technology for the firm's purpose.^[3] The optimal combination of inputs is the least cost combination of inputs for desired level of output when all inputs are variable.^[2] Regardless once the decisions are made and implemented and production begins the firm is operating in the short run with fixed and variable inputs.^[2][4]

The law of diminsihing marginal returns does not apply in the long run.^[5] The law examines the effect on output of increaseing the use of an input while other inputs are fixed.^[6] In the long run all inputs are variable in the sense that they can be changed. The law of diminishing returns determines the shape of short run cost curves. The shape of the long run marginal and average costs curves is determined by economies of scale.^[7]

Comparing Short run to long run

• Important cost functions

SR: total function:

Total costs: C(Q) = FC + VC

Total variable cost: VC(Q) costs that vary with output

Total fixed cost: FC costs that do not vary with output

Per unit functions

Marginal costs: ∆C/∆Q

Average cost: C/Q = C(Q)/Q = AVC + AFC

Average variable cost: VC(Q)/Q

Average fixed cost: FC/Q

LR:Total

Total cost: C

Per unit function

Marginal costs: ∆C/∆Q

Average costs: C/Q

• Inputs:

SR: at least one input is fixed

LR: all inputs are variable

• Purpose

:SR: Production

LR: Planning and Implementation

• Guiding Principle

SR: Law of diminishing marginal returns

LR: Economies of scale

See also

• Long run average cost
• Long run marginal cost
• Short-run

Footnotes

References

1. Boyes, W. 2004 The New Managerial Economics, Houghton Mifflin ISBN 039582835X

2. Melvin & Boyes, 2002 Microeconomics 5th ed. Houghton Mifflin.

3. Perloff, J: 2008 Microeconomics Theory & Applications with Calculus Pearson. ISBN 9780321277947

4. Pindyck, R & Rubinfeld, D: 2001 Microeconomics 5th ed. Prentice-Hall. ISBN 0130196738