Short Run vs. Long Run: Shutdown, Exit and Fixed Costs
Short run and long run describe which inputs and costs can change, not a fixed number of months. A competitive firm may produce at a loss when doing so covers variable cost and reduces its loss from unavoidable fixed cost. Long-run planning also allows changes in plant size and entry or exit. Keep those decisions separate.
Fixed inputs and entry differ across horizons.
Read Three Time-Horizon Examples
At the output where P=MC, a competitive firm observes a price of $18, AVC of $15, and ATC of $21. The firm should
- produce in the short run while earning a loss
- shut down immediately because profit is negative
- raise its price above the market price
- produce where price equals ATC instead
- exit before fixed contracts expire
produce in the short run while earning a loss Price covers variable cost and contributes toward fixed cost, so producing minimizes the short-run loss even though economic profit is negative.
Which supply is likely to be least elastic in the immediate market period?
- Seats for tonight’s sold-out concert
- Restaurant meals over the next year
- New houses over a decade
- Manufactured shirts over six months
- Wheat over several planting seasons
Seats for tonight’s sold-out concert The number of seats available tonight is fixed, so immediate supply is nearly vertical. Longer horizons allow productive capacity to adjust.
A vertical supply curve indicates that quantity supplied is
- unit elastic
- perfectly inelastic
- perfectly elastic
- income elastic
- more responsive in the long run than the short run
perfectly inelastic A vertical curve holds quantity fixed when price changes, so supply elasticity is zero.
Video Lesson: Short-Run Shutdown and Long-Run Exit
A focused video lesson from econhelp.
Separate Operating, Entry and Scale Decisions
A competitive firm can operate at a loss in the short run if price covers AVC, but it exits in the long run if revenue cannot cover total cost. Profit causes entry only in the long run. A fixed fee does not shift short-run MC but can influence long-run entry. Diminishing marginal returns are short run. Economies of scale are long run.
Identify Which Inputs Are Fixed
The short run is a decision horizon in which at least one input is fixed. It is not a universal number of months. The long run allows all inputs and entry or exit to adjust. A restaurant’s dining room may be fixed tonight but variable over several years, while a software firm may change server capacity quickly. Use the stated constraints rather than a calendar rule.
Distinguish a Fixed Fee from a Per-Unit Cost
A fixed license fee that must be paid regardless of current output changes the firm’s short-run profit calculation without changing the added production cost of its next unit. AFC and ATC rise, while AVC and MC remain in place. Conditional on operating, the MR=MC output is therefore unchanged. A per-unit fee belongs in variable and marginal cost and can alter both output and the shutdown decision.
Compare the Short-Run and Long-Run Benchmarks
| Decision | Short-run benchmark | Long-run benchmark |
|---|---|---|
| Competitive operation | Operate above minimum AVC; indifferent at equality in the basic model | Choose a feasible plan that covers all economic cost, or exit |
| Industry adjustment | Number of firms fixed | Entry or exit shifts supply |
| Production law | Diminishing marginal returns | Returns to scale |
| Cost | Some fixed cost unavoidable | All cost avoidable in planning |
Explain Why Operating Can Reduce a Loss
At the P=MC output, price is $14, AVC is $10, and ATC is $17. Producing contributes $4 per unit toward fixed cost, so the firm loses less than if it shut down. It operates in the short run but exits in the long run if conditions persist.
Trace Entry and Exit Through Market Supply
Long-run entry and exit change the number of firms and market supply; plant-size adjustment changes an individual firm’s feasible scale. Positive economic profit attracts firms, shifts market supply right, and lowers price. Loss causes exit, shifts supply left, and raises price. In a constant-cost competitive industry, adjustment ends at minimum ATC. Increasing- or decreasing-cost industries can have different long-run supply shapes.
Separate Diminishing Returns from Scale Effects
Diminishing marginal returns and diseconomies of scale are not synonyms. Diminishing returns occurs when more of a variable input is added to fixed inputs. Diseconomies of scale occurs when all inputs expand and output rises by a smaller proportion. One is short-run input crowding. The other is a long-run scale relationship.
Check Which Entry Restrictions Remain
Market-structure outcomes also change with horizon. A patent can sustain monopoly while legal entry is blocked. Expiration permits entry. Monopolistic competitors may earn short-run profit, but entry shifts individual demand until profit is zero. Always ask which adjustments the problem allows before invoking entry, plant-size change, or fixed-cost avoidance.
Follow a Demand Change Across Both Horizons
A change can have both horizons. A sudden increase in demand raises price and profit when the number of competitive firms is fixed. Over time, entry expands market supply and erodes profit. If the industry uses specialized inputs, their prices may rise as the industry expands, so the final long-run price need not return exactly to its old level. Use the constant-cost result only when that assumption is stated or implied.
Check Shutdown, Cost and Entry Assumptions
OpenStax’s short-run cost section separates total, fixed, variable and marginal cost. The long-run cost section allows all inputs to vary. Returns to scale describe proportional input and output changes; economies or diseconomies of scale describe how average cost changes with scale.
The competitive output and shutdown discussion compares revenue with avoidable variable cost. Under the basic model, price below minimum AVC implies shutdown. At minimum AVC, producing at the corresponding quantity and shutting down give the same loss from unavoidable fixed cost. A price equal to MC alone does not establish that producing is best.
The entry and exit section explains adjustment under free competition. Zero economic profit includes normal compensation for the owner’s resources. For a fixed fee, ask whether it is already sunk, unavoidable under both current choices or avoidable by not operating. A fee avoidable on shutdown can change that decision even though it does not change MC conditional on operating. Focus the comparison table and use horizontal arrow keys on a narrow screen.
Calculate the Effect of Two Different Fees
A hypothetical firm currently produces 5 units. Compare a new $30 fixed fee that is unavoidable whether it produces or shuts down with a $2 fee on each unit produced. Hold technology and other input prices fixed. How do these fees affect cost measures?
Check your reasoning
At 5 units, the unavoidable fixed fee adds $30 ÷ 5 = $6 to AFC and ATC. It does not add to AVC or the cost of another unit. The $2 per-unit fee adds $2 to AVC, ATC and MC. The fixed fee’s average effect depends on output; the per-unit fee’s effect is $2 at every positive output. These are conditional cost comparisons, not proof that the firm should keep its old output or remain in the industry.
Try Three Time-Horizon and Cost Questions
Choose one answer, then check your reasoning. These are short learning checks, not an exam score. If the controls are unavailable, the explanations remain readable below each question.
Answer A. Revenue is $80, variable cost is $60 and total cost is $110. Fixed cost is $50. Producing loses $30; shutdown avoids variable cost but still loses the $50 fixed cost.
Answer B. The horizon depends on input flexibility, not a universal calendar length. What is fixed for one firm or decision can be adjustable for another.
Answer D. An output-independent, unavoidable fee changes fixed cost and total cost, not the added cost of another unit. Its average cost effect is the fee divided by positive output. A fee avoidable on shutdown would require a different operating comparison.
Connect the Firm with Market Adjustment
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