Long run and short run cost functions

In the long run, the firm can vary all its inputs. In the short run, some of these inputs are
fixed. Since the firm is constrained in the short run, and not constrained in the long run, the
long run cost TC(y) of producing any given output y is no greater than the short run cost
STC(y) of producing that output:
TC(y) STC(y) for all y.

Now consider the case in which in the short run exactly one of the firm's inputs is fixed. For
concreteness, suppose that the firm uses two inputs, and the amount of input 2 is fixed at k.
For many (but not all) production functions, there is some level of output, say y , such that the
0

firm would choose to use k units of input 2 to produce y , even if it were free to choose any
0

amount it wanted. In such a case, for this level of output the short run total cost when the firm
is constrained to use k units of input 2 is equal to the long run total cost: STC (y ) = TC(y ).
k 0 0

We generally assume that for any level at which input 2 is fixed, there is some level of output
for which that amount of input 2 is appropriate, so that for any value of k,

TC(y) = STC (y) for some y.

k

(There are production functions for which this relation is not true, however: see the example
of a production function in which the inputs are perfect substitutes.)

Example: a production function in which the inputs are perfect

substitutes
Consider the production function F (z , z ) = z + z , in which the inputs are
1 2 1 2

perfect substitutes. The long run total cost function for this production function is
given by

w 1
if w < w
1 2
y

TC(y,w ,w
1 if w =
2 1
wy
)= w =w 2

w 2
if w > w
1 2
y

Its short run total cost of production when the amount of input 2 is fixed at k is

STC (y)
k if y
wk 2
= k

w (y
1 k) + if y >
wk
2 k.

Note that in this case if w < w then there is no level of output for which short
1 2

run total cost is equal to the long run total cost. In this case the firm would like to
use only input 1 to produce any output, so if k > 0 there is no output for which
the short run total cost is equal to the long run total cost. The short and long run
cost functions in this case are shown in the following figure.
Example: a Cobb-Douglas production function
Consider the production function F (z , z ) = z z . The long run total cost
1 2 1
1/2
2
1/2

function for this production function is given by

TC(y,w ,w ) = 2y(w w ) .
1 2 1 2
1/2

Its short run total cost of production when the amount of input 2 is fixed at k is

STC (y) =w y /k + w k.
k 1
2
2

Note that TC is a linear function of y while STC is a quadratic function.

(Remember that w and w are fixed.) The functions are shown in the following
1 2

figure.

For a total cost function with the typical shape, the following figure shows the relations
between STC and TC.
Examples of long run and short run cost functions

Example of long run and short run cost functions

Example: a production function with fixed proportions
Consider the fixed proportions production function F (z , z ) = min{z , z } (one
1 2 1 2

worker and one machine produce one unit of output). The long run total cost
function for this production function is given by

TC(y,w ,w ) = w y + w y = (w + w )y.
1 2 1 2 1 2

Its short run total cost of production when the amount of input 2 is fixed at k is

STC (y) w y +
k 1 if y
= wk 2 k

if y >
k.

These functions are shown in the following figure.

Example: a production function in which the inputs are perfect
substitutes
Consider the production function F (z , z ) = z + z , in which the inputs are
1 2 1 2

perfect substitutes. The long run total cost function for this production function is
given by

w 1
if w < w
1 2
y

TC(y,w ,w
1 2if w = 1
wy
)= w =w 2

w 2
if w > w
1 2
y

Its short run total cost of production when the amount of input 2 is fixed at k is

STC (y)
k if y
wk 2
= k

w (y
1 k) + if y >
wk
2 k.

Note that in this case if w < w then there is no level of output for which short
1 2

run total cost is equal to the long run total cost. In this case the firm would like to
use only input 1 to produce any output, so if k > 0 there is no output for which
the short run total cost is equal to the long run total cost. The short and long run
cost functions in this case are shown in the following figure.

Example: a Cobb-Douglas production function

Consider the production function F (z , z ) = z z . The long run total cost
1 2 1
1/2
2
1/2

function for this production function is given by

TC(y,w ,w ) = 2y(w w ) .
1 2 1 2
1/2
Its short run total cost of production when the amount of input 2 is fixed at k is

STC (y) =w y /k + w k.
k 1
2
2

Note that TC is a linear function of y while STC is a quadratic function.

(Remember that w and w are fixed.) The functions are shown in the following
1 2

figure.

Long run and short run average cost functions

Given the relation between the short and long run total costs, the short and long
run average and marginal cost functions have the forms shown in the following
figure.

Note:
 • The SMC goes through the minimum of the SAC and the LMC goes through
the minimum of the LAC.
• When SAC = LAC we must have SMC = LMC (since slopes of total cost
functions are the same there).

In the case that the production function has CRTS, the LAC is horizontal, as in the
following figure.

The long run and the short run do not refer to a specific period of time such as 3 months or 5
years. The difference between the short run and the long run is the flexibility decision makers
have. The 2nd edition of Parkin and Bade's "Economics" gives an excellent distinction between the
two:

"The short run is a period of time in which the quantity of at least one input is fixed and the
quantities of the other inputs can be varied. The long run is a period of time in which the
quantities of all inputs can be varied.

There is no fixed time that can be marked on the calendar to separate the short run from the long
run. The short run and long run distinction varies from one industry to another." (239)

I find examples helpful, so we'll consider a hockey stick manufacturer. A company in that industry
will need the following to manufacture sticks:

• Raw materials such as lumber

• Labor
• Machinery
• A factory

Suppose the demand for hockey sticks has greatly increased, prompting our company to produce
more sticks. We should be able to order more raw materials with little delay, so we consider raw
materials to be a variable input. We'll need extra labor, but we can likely increase our labor supply
by running an extra shift and getting existing workers to work overtime, so this is also a variable
input. The equipment on the other hand, may not be a variable input. It may be time consuming
to implement the use of additional equipment. It depends how long it would take us to buy and
install the equipment and how long it would take us to train the workers to use it. Adding an extra
factory is certainly not something we could do in a short period of time, so this would be the fixed
input.

Using the definitions given at the beginning of the article, we see that the short run is the period in
which we can increase production by adding more raw materials and more labor. In the short run
we cannot add another factory, but in the long run all of our inputs are variable, including our
factory space.

The increase in demand for hockey sticks will have different implications in the short run and the
long run at the industry level. In the short run each of the firms will increase their labor supply and
raw materials to meet the added demand for hockey sticks. At first only existing firms will be likely
to capitalize on the increased demand as they will be the only ones who will have access to the
four inputs needed to make the sticks. However we know that in the long run the factor input is
variable as well. This means that existing firms can change the size and number of factories they
own and new firms can build or buy factories to produce hockey sticks. In the long run we will see
new firms enter the hockey stick market, while we will not in the short run because firms will not
be able to acquire all of the inputs they need.

Short Run vs. Long Run In Summary

Short Run: Some inputs variable, some fixed. New firms do not enter the industry, and existing
firms do not exit.

Long Run: All inputs variable, firms can enter and exit the market place.

• TIME IS an important parameter in the science of economics. It is

used in various contexts and various ways. For example, time is
used in static and dynamic analysis in the sense that in static
analysis time is regarded as a constant, whereas in dynamic
analysis it is assumed to be a variable. Time is also used in the
theories of consumption, production and market systems. We will
just look at the short-run and long-run aspects of this parameter.
One of the contexts where short-run and long-run time periods are
quite used is the theory of the firm. In this context, short-run is a
time period within which a firm is not able to vary all its factors of
production. There can, in fact, be several ‘short-runs’, of varying
lengths, corresponding to the particular possibilities which the firm
has of varying particular inputs. For example, in the very short-run,
say one week or so the firm may not be able to change the amounts
of any the inputs it uses, although it could perhaps increase labour
inputs by increasing overtime working in period less than this. Over
a month, however, it may be able to expand its labour force and
increase the flow of raw materials, over a year, it may be able to
increase all its inputs, except, perhaps, certain types of machinery,
which perhaps take two years to obtain and install. Hence, the
short-run for the firm will be anything less than two years.
However, the firm may itself have it within its power to shorten the
short-run by incurring higher costs. For example, the firm could rent
the machinery, at a premium and so obtain it in less than two
years; or the firm may pay more to shorten the delivery of time.
This means that what is the short-run to a firm is as much an
economic as technological question. More generally, the term short-
run may be applied to any time period not long enough to allow the
full effects of some changes to have operated. In other words,
short-run in any context is that time period when all the possible
adjustments that the economic agent desires fail to occur.

Long-run is strictly defined as the time period long enough for the
firm to be able to vary the quantities of all its factors of production,
rather than just some of them. For example, suppose that a firm
uses labour, raw materials and machinery to make a particular
product. Labour is hired on a weekly contract; raw materials take
one month to arrive, from date of order, while plant and machinery
takes two years to design, order, construct and install. The long-run
for this firm is therefore two years, since over this time the firm can
vary all its factors of production. The implication of the definition is
that the long –run is not a fixed period of time for all the firms in all
industries, but rather varies with the characteristics of an industry’s
technology.

Thus the electricity supply industry requires five to six years to

plan, construct and install new generating capacity and so its long
run is five to six years. We must note that although it is normally
assumed that the long run is determined by the time period
required to extend plant capacity, this need not always be the case
and the definition of the long-run is perfectly neutral as regards
which input (or inputs) actually determines long-run. The
importance of the long-run in the theory of the firm is that it is long
enough to permit the firm to choose the most efficient combination
of inputs to produce any given output. More generally, the long-run
is often loosely taken as the period long enough for underlying
economic factors causing tendencies to change to work themselves
out fully. In other words, long-run in any context is that time period
when all the possible adjustments that the economic agent desires
occur. It was in this sense that Keynes used the term in his famous
dictum: “In the long run we are all dead.”