Question

“Changes in demand have different effects on profit over different time horizons (short run versus long run)”. Explain this phenomenon using an example of a demand increase or a demand decrease.

Answer 1

1. Suppose, there's an increase in demand for Cricket bats in the market and in order to produce and meet the short term demand, the manufacturers will be able to induce more labour and raw materials to meet the demand. At this stage, only existing firms will be able to capitalize as they could cope up with all the four categories of inputs whereas the new firms entering might not capitalize as they are not standard enough to withstand the competition of the existing firms in the short term.

2. In the long run, the existing firms might need the help of the newer firms to meet the demand and hence the non existing or say the newer firms will also be able to capitalize or earn profits according to the demand.

3. This happens in the same way if the demand is decreased. The advantage will be on the existing firms as they could with stand the time gap where the newly entering firms will be wiped out due to absence of demand for them to capitalize. These points also include the quality of labour and raw materials but this is the secondary aspect.