Costs, Revenue and Profit: Short Run vs Long Run
EconomicsΒ· Unit 2: The Price System and the Microeconomy, Topic 6Β· 25 min read
1. Core Definitions: Short Run vs Long Runβ β ββββ± 5 min
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 cafΓ© 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).
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.
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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.
2. Short Run Costs, Revenue and Profitβ β β βββ± 8 min
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 ().
Example:
A firm with TR = $10,000 per month, fixed cost = $3,000, variable cost = $5,000 has SR profit of $2,000.
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:
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- 3
Calculate total variable cost:
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- 5
Calculate total cost:
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- 7
Calculate total profit:
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Final answer: Short run total profit is $1000.
Check your understanding:
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
Reveal answer
At least one factor is fixed βCorrect. This is the core definition of the short run.
3. Long Run Costs and Returns to Scaleβ β β βββ± 7 min
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.
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
- 3
Compare to the percentage change in inputs: Inputs increased by 20%, and output increased by 25%, which is a larger proportional change.
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Conclusion: A larger proportional increase in output than inputs means this is increasing returns to scale.
4. Comparing Short Run and Long Run Profitβ β β β ββ± 8 min
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.
A firm in perfect competition is earning supernormal profit in the short run. Explain what will happen to profit in the long run.
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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).
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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.
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At this point, total revenue equals total cost, so firms earn only normal profit, and there is no further incentive for new entry.
5. Common Pitfalls
Wrong move:
Defining the short run as any period less than one calendar year
Why:
Examiners specifically mark this wrong, because the distinction is based on fixed factors not calendar time
Correct move:
Define the short run as a period where at least one factor of production is fixed
Wrong move:
Confusing diminishing marginal returns (short run) with decreasing returns to scale (long run)
Why:
Diminishing returns applies only when one factor is fixed, while decreasing returns to scale applies when all factors are variable
Correct move:
Explicitly label which concept you are using: diminishing returns for short run costs, decreasing returns to scale for long run costs
Wrong move:
Ignoring fixed costs when calculating short run profit
Why:
Fixed costs are still an economic cost to the firm in the short run, so they must be included
Correct move:
Always use total cost (fixed + variable) when calculating total profit, regardless of time frame
Wrong move:
Assuming all large firms experience diseconomies of scale
Why:
Diseconomies of scale only occur beyond the minimum efficient scale; many large firms operate on the flat part of the LRAC curve
Correct move:
Evaluate returns to scale based on the information provided, not just the size of the firm
Wrong move:
Claiming firms always earn more profit in the long run than the short run
Why:
In competitive markets, long run profit is lower than short run supernormal profit due to new entry
Correct move:
Analyse the effect of entry and exit on market supply and price to determine long run profit outcomes
6. Quick Reference 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 |
7. Frequently Asked
Is the short run always 1 year or less?
No. The short run is defined by the presence of fixed factors, not a specific calendar length. For a heavy manufacturing firm, the short run could be several years, while for a pop-up market stall it can be a single day.
When this came up on past exams
AI-estimated based on syllabus patterns β cross-check with official past papers for accuracy. Use only as revision-focus signals.
- 2022 Β· 12
Compare short run vs long run cost curves
- 2023 Β· 22
Discuss the concept of returns to scale
- 2021 Β· 11
Calculate short run vs long run profit
Going deeper
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.