# Costs, Revenue and Profit: Short Run vs Long Run

> Economics · CIE A-Level
> Source: https://www.owlsprep.com/study/cie-9708-u2-costs-revenue-and-profit-short/

This module explains the core difference between the short run and long run time frames for firms, and how this distinction impacts costs, revenue, profit levels, and long run production decisions for profit-maximising firms.

**Prerequisites:** [Factors of production](https://www.owlsprep.com/study/cie-9708-u2-production-and-productivity/); [Short run cost curves](https://www.owlsprep.com/study/cie-9708-u2-cost-curves/)

## Learning objectives

- Distinguish between short run and long run production periods
- Calculate and compare short run and long run costs, revenue and profit
- Explain the relationship between returns to scale and long run average cost
- Evaluate how firm outcomes differ between short and long run

## Core Definitions: Short Run vs Long Run

The key distinction between the short run (SR) and long run (LR) does not rely on a fixed amount of calendar time, but on the flexibility of a firm's factors of production.

**Short Run vs Long Run** — Short run: At least one factor of production is fixed (cannot be adjusted), while all other factors are variable. Long run: All factors of production are variable, so the firm can fully change its entire production scale.

*Example:* A café cannot expand its building in 1 month (capital fixed = short run), but over 2 years it can buy adjacent property and new equipment (all factors variable = long run).

> **warning**
>
> Multiple choice questions regularly test whether you know the distinction is based on fixed factors, not calendar time. This is one of the most common traps on this topic.

**Worked example:** A new bakery signs a 12-month fixed rental contract for its premises. Is this 12-month period the short run for the bakery, and why?

1. Identify the fixed factor: The fixed rental contract means the size of the premises (capital) cannot be changed for 12 months.
2. Check variable factors: The bakery can vary the number of bakers (labour), amount of flour (raw materials), and hours of operation, which are all variable.
3. Conclusion: Since at least one factor (capital) is fixed, this 12-month period is the short run for the bakery.

## Short Run Costs, Revenue and Profit

In the short run, the law of diminishing marginal returns applies to variable factors, because at least one factor is fixed. This causes the short run average cost (SRAC) curve to be U-shaped: initial falling average cost from specialisation, followed by rising average cost as diminishing returns set in.

**Short Run Total Profit** — Total revenue (TR) minus total short run cost (TC), where TC includes both fixed and variable costs. Firms maximise short run profit where marginal revenue equals short run marginal cost ($MR = MC$).

*Notation:* \pi_{SR}

*Example:* A firm with TR = \$10,000 per month, fixed cost = \$3,000, variable cost = \$5,000 has SR profit of \$2,000.

**Worked example:** A shirt manufacturer has fixed monthly costs of \$2000. Each shirt costs \$5 to make (variable cost) and sells for \$15. The firm sells 300 shirts in one month. Calculate the short run total profit.

1. Calculate total revenue:
2. $$TR = P \times Q = 15 \times 300 = 4500$$
3. Calculate total variable cost:
4. $$TVC = AVC \times Q = 5 \times 300 = 1500$$
5. Calculate total cost:
6. $$TC = TFC + TVC = 2000 + 1500 = 3500$$
7. Calculate total profit:
8. $$\pi = TR - TC = 4500 - 3500 = 1000$$
9. Final answer: Short run total profit is \$1000.

**Check your understanding**

Check your understanding:

1. Which of the following is always true of the short run?

   - All factors are fixed
   - At least one factor is fixed
   - All factors are variable
   - Capital is always variable

   *Why:* Correct. This is the core definition of the short run.

## Long Run Costs and Returns to Scale

In the long run, all factors are variable, so firms can adjust their entire production scale. The long run average cost (LRAC) curve is an 'envelope' of all possible SRAC curves, each for a different plant size. The shape of the LRAC is determined by returns to scale.

**Returns to Scale** — Measures how output changes when all inputs are increased by the same proportion in the long run. There are three types: increasing, constant, and decreasing returns to scale.

*Example:* If all inputs increase by 50% and output increases by 70%, this is increasing returns to scale.

**Worked example:** A factory increases all inputs by 20%. Output increases from 1000 units to 1250 units. What type of returns to scale is this?

1. Calculate the percentage change in output:
2. $$\%\Delta Output = \frac{1250 - 1000}{1000} \times 100 = 25\%$$
3. Compare to the percentage change in inputs: Inputs increased by 20%, and output increased by 25%, which is a larger proportional change.
4. Conclusion: A larger proportional increase in output than inputs means this is increasing returns to scale.

> **tip**
>
> Increasing returns to scale cause falling LRAC (economies of scale), while decreasing returns to scale cause rising LRAC (diseconomies of scale).

## Comparing Short Run and Long Run Profit

In the long run, firms can enter or exit the market, and adjust their plant size to produce at the minimum efficient scale. In perfectly competitive markets, this process means long run equilibrium will always see firms earn only normal profit (zero supernormal profit), while in the short run firms can earn supernormal profit or make losses.

**Long Run Profit Maximisation** — Firms choose the plant size that delivers the lowest possible average cost for their desired output, and maximise profit where long run marginal cost equals long run marginal cost.

**Worked example:** A firm in perfect competition is earning supernormal profit in the short run. Explain what will happen to profit in the long run.

1. Supernormal profit signals to outside firms that this market is profitable, so new firms will enter the market in the long run (no barriers to entry in perfect competition).
2. New entry increases total market supply, which pushes down the equilibrium market price.
3. Price continues to fall until it equals the minimum point of the firm's long run average cost curve.
4. At this point, total revenue equals total cost, so firms earn only normal profit, and there is no further incentive for new entry.

**Exam command terms**

Common command terms for this topic:

- **Distinguish** — You must clearly state the core difference between two concepts, using definitions *(Distinguish between short run and long run requires referencing fixed vs variable factors)*

- **Compare** — You must highlight both similarities and differences between short run and long run outcomes *(Compare short run and long run profit requires discussing the effect of entry and exit)*

## Common pitfalls

- **Wrong:** Defining the short run as any period less than one calendar year
  - Why it fails: Examiners specifically mark this wrong, because the distinction is based on fixed factors not calendar time
  - Correct: Define the short run as a period where at least one factor of production is fixed
- **Wrong:** Confusing diminishing marginal returns (short run) with decreasing returns to scale (long run)
  - Why it fails: Diminishing returns applies only when one factor is fixed, while decreasing returns to scale applies when all factors are variable
  - Correct: Explicitly label which concept you are using: diminishing returns for short run costs, decreasing returns to scale for long run costs
- **Wrong:** Ignoring fixed costs when calculating short run profit
  - Why it fails: Fixed costs are still an economic cost to the firm in the short run, so they must be included
  - Correct: Always use total cost (fixed + variable) when calculating total profit, regardless of time frame
- **Wrong:** Assuming all large firms experience diseconomies of scale
  - Why it fails: Diseconomies of scale only occur beyond the minimum efficient scale; many large firms operate on the flat part of the LRAC curve
  - Correct: Evaluate returns to scale based on the information provided, not just the size of the firm
- **Wrong:** Claiming firms always earn more profit in the long run than the short run
  - Why it fails: In competitive markets, long run profit is lower than short run supernormal profit due to new entry
  - Correct: Analyse the effect of entry and exit on market supply and price to determine long run profit outcomes

## Cheatsheet

| Feature | Short Run | Long Run |
| --- | --- | --- |
| Factors of production | At least one fixed, rest variable | All factors variable |
| Key cost driver | Law of diminishing marginal returns | Returns to scale |
| Average cost shape | U-shaped from diminishing returns | U-shaped from economies/diseconomies of scale |
| Market entry/exit | Not possible | Free entry and exit |
| Perfect competition profit | Can be supernormal, normal or loss | Always normal profit in equilibrium |

## What's next

Understanding the difference between short run and long run firm behaviour is the foundation for analysing market structure and how firms adjust to changing demand and cost conditions. Next, you will build on this to study how different market structures, from perfect competition to monopoly, produce different short run and long run outcomes for price, output and consumer welfare. This distinction also underpins analysis of economies and diseconomies of scale, which is key for evaluating the impact of firm growth and mergers on consumer welfare. Mastering this topic will help you access higher marks on data response and essay questions that ask you to compare short run and long run adjustments to external shocks.

- [Perfect Competition](https://www.owlsprep.com/study/cie-9708-u2-perfect-competition/)
- [Monopoly](https://www.owlsprep.com/study/cie-9708-u2-monopoly/)
- [Returns to Scale](https://www.owlsprep.com/study/cie-9708-u2-returns-to-scale/)

---

From [OwlsPrep](https://www.owlsprep.com) — free study guides for A-Level, IB, AP and IGCSE, written against the official syllabus. Canonical page: https://www.owlsprep.com/study/cie-9708-u2-costs-revenue-and-profit-short/