Question

5. How does short-run and long run profit affect the real world? Give examples.

Answer 1

The number of corporations is fixed in the short run. A company may be making large profits, small profits, no profits or a loss, depending on its cost and revenue; and it may continue to do so in the short term. However, in the long run the level of profits affects the industry's entry and exit. Where profits are high, new firms will be drawn into the industry, while firms will leave if losses are made.

In contrast, economists often define the short run as the time horizon over which the scale of an operation is set, and the only business decision available is the number of employees to be employed. (Technically, the short-term could also represent a situation in which the quantity of labor is fixed and the quantity of capital variable, but this is quite uncommon.) The logic is that even if different labor laws are taken as a given, it is usually easier to hire and fire workers than changing a major production process or moving to a new factory or office considerably. (One reason for this probably concerns long-term leases, and so on.)

Obviously the company would need a larger headquarters if it were to decide to expand significantly, but this scenario refers to the long-run decision to choose a production scale. In the long run, there are no genuinely fixed costs as the firm is free to choose the scale of operation that determines the level at which the costs are set. In addition, there are no long-term sunk costs, as the company has the option of not doing business at all and incurring zero costs.