Short Run Profit
In an economic market all production in real time occurs in the short run. The short run is the conceptual time period where at least one factor of production is fixed in amount while other factors are variable in amount. Fixed costs have no impact on a firm's short run decisions. However, variable costs and revenues affect short run profits. In the short run, a firm could potentially increase output by increasing the amount of the variable factors. An example of a variable factor being increased would be increasing labor through overtime.
In the short run, a firm that is maximizing its profits will:
- Increase production if the marginal cost is less than the marginal revenue.
- Decrease production if marginal cost is greater than marginal revenue.
- Continue producing if average variable cost is less than price per unit.
- Shut down if average variable cost is greater than price at each level of output.
Transition from Short Run to Long Run Profit
When a firm is transitioning from the short run to the long run it will consider the current and future equilibrium for supply and demand. The firm will also take adjustments into account that can disturb equilibrium such as the sales tax rate. The transition involves analyzing the current state of the market as well as revenue and combining the results with long run market projections.
Short Run Shutdown vs. Long Run Exit
The goal of a firm is to maximize profits by minimizing losses. In economics, a firm will implement a production shutdown when the revenue coming in from the sale of goods cannot cover the variable costs of production. The firm would experience higher loss if it kept producing goods than if it stopped production for a period of time. Revenue would not cover the variable costs associated with production. Instead, during a shutdown the firm is only paying the fixed costs.
A short run shutdown is designed to be temporary: it does not mean that the firm is going out of business. If market conditions improve, due to prices increasing or production costs falling, the firm can restart production. When a firm is shut down in the short run, it still has to pay fixed costs and cannot leave the industry. However, a firm cannot incur losses indefinitely. Exiting an industry is a long term decision. If market conditions do not improve a firm can exit the market. By exiting the industry, the firm earns no revenue but incurs no fixed or variable costs.
Short Run Supply Curve
In a perfectly competitive market, the short run supply curve is the marginal cost (MC) curve at and above the shutdown point. The portions of the marginal cost curve below the shutdown point are no part of the supply curve because the firm is not producing in that range. The short run supply curve is used to graph a firm's short run economic state .
Short run supply curve
This graph shows a short run supply curve in a perfect competitive market. The short run supply curve is the marginal cost curve at and above the shutdown point. The portions of the marginal cost curve below the shutdown point are not part of the supply curve because the firm is not producing in that range.