Time is an important variable in economics. The time it takes to ship goods from one place to another, the time a product is sitting in a warehouse and the amount of time it takes to build a new store or factory are all factors that determine the price of goods. In economics, the short-run is a variable concept that relates to how prices may quickly shift to restore market equilibrium.
Aggregate supply is an economy's total ability to meet demand for goods and services at any particular price point. When economists talk about short-run and long-run adjustments, they are referring to the elasticity of the aggregate supply--whether an economy can produce more.
Short-Run vs. Long-Run
Short-run economics primarily affect price. When demand decreases for any reason, prices go down in the short term. When demand spikes, prices go up. This is how the market corrects itself in the short-run. Long-run adjustments occur when sustained increases or decreases in demand cause a business to change its practices and can affect both price and the means of production.
Negative Output Gaps
Short-run aggregate supply is a measure of an economy's production capacity. If an economy's total gross domestic product (GDP) is less than its potential GDP, that's a negative output gap. That means a lot of businesses are not producing to capacity; factories aren't operating full-bore, and workers could be doing much more before a company would have to pay them overtime.
Positive Outcome Gaps
When companies begin to increase production to meet new demand for their products, they may have some breathing room to kick operations up a notch without increasing costs too much. Perhaps business owners don't hire new people, but they do pay their existing employees overtime. They don't build a new factory, but they do run their existing factories around the clock. At this point, the short-run aggregate supply becomes inelastic. Without changing operations, the economy can't produce more goods.
Short-run and long-run are important concepts, though they differ from company to company. Some business models are simply more flexible than others. For manufacturers that need to design and construct enormous, expensive facilities to increase production, the short-run lasts as long as it takes to complete the project. For a small consulting firm, the short-run might be only as long as it takes to hire a new staff member.
- Photo Credit Economic crisis image by Denis Ivatin from Fotolia.com
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