Theory: Short-Run versus Long-Run Elasticities

Microeconomics: Short-Run versus Long-Run Elasticities

If we ask ourselves the question: ‘how much does demand or supply change in response to a change in on its determinants?’ we must define the period of time in which we are referring to i.e. how much time is allowed to pass before we measure the changes in quantity demanded/supplied. This is an essential element to the study of economies. In economics we refer to the short run and the long run. The short run is typically defined as one year or less and the long run is defined as the time period in which consumers/producers are allowed to full adjust to changes in price or other determinants. In essence, the curves of supply and demand in the short run are different than their counterparts in the long run.

First of all let’s look at demand. The case is that the demand curve for most goods in the long run is more price elastic than in the short run. This is for several reasons. One of these is that it takes time for people to alter their spending habits. Moreover, the demand for a good may be related to the stock of a different good that changes more slowly.

On the contrary, the opposite holds true for other goods where demand is more elastic in the short run than in the long run. Typically these goods are capital stock/equipment i.e. cars, TVs or other durable goods. The total stock of each good owned by the consumer is large relative to yearly production. Due to this, a small change in the aggregate stock that consumers want can cause a large percentage change in the level of purchases. Consider the case of cars, although annual demand for new ones is well in to the millions, the stock that people own is usually 10 times the size of the demand. The quantity demanded will drop fast is prices rise because people will put off buying them for the time being. Eventually however, because older cars wear out and need to be replaced, the quantity demanded of new cars – in the long run – will rise again. As a result of this, long run change in the quantity demanded is more inelastic than in the short run. People will always need cars!

Furthermore, we have income elasticities. They too differ in the short run and in the long run. For most goods (normal goods) the YED is larger in the long run than it is in the short run. Similarly with demand elasticity, the opposite is true for durable goods where short run elasticity is greater than in the long run.

Now, if we look at this concept and apply it to the wider economy it leads us to such a thing called cyclical industries. These are defined as industries in which sales end to magnify changed in GDP and national income. BECAUSE the demand for durable goods (capital equipment etc.) fluctuate violently in response to short run alterations in national income, the industries that produce said goods are therefore obviously more vulnerable to changing macroeconomic conditions. This brings us on to the business cycle – the cyclical view that the economy goes through stages (recessions/booms etc.). The cyclical industries have sales patterns that tend to magnify the cyclical changes in GDP and national income levels. Typically, the sales of durable equipment (investment) follow the same pattern as GDP but these sales are much larger than the changes in GDP and are so described as being ‘magnified’. So, in a boom phase the purchases of capital equipment grow faster than GDP does and on the contrary, in a recession phase the equipment purchases fall faster than levels of GDP fall.

Looking further into this idea, levels of consumer expenditure follow and match the levels of GDP over time however, only the purchases of capital equipment (investment) magnify these changes. This means that there are companies out there (those that sell TVs, cars etc.) who are considered ‘cyclical’ i.e. General Motors and General Electric.

Now let’s look at the other side of the coin: elasticities of supply. These also differ between the long run and the short run. For most products, long run supply is typically more elastic than in the short run. This stems from a few causes. One of these is capacity constraint whereby firms need time to expand capacity buy searching and hiring more workers or building new factories. This doesn’t mean that the quantity supplied won’t rise in the short run, however. If price rises quickly in the short run then a firm can expand capacity by hiring workers overtime or hiring new workers immediately. This just means that firms will expand their supply capabilities when they have the time to do so and think carefully about their decisions.

It should be noted that some goods have a completely inelastic short run supply. Take the example of house renting. In the short run, there is only a fixed number of available housing. This means that a rise in its demand level would purely cause rent prices to increase. In the long run though, provided there is no rent control, higher levels of rent would be a motivation for new construction of rentable housing.

It should be duly noted that more often than not firms will find methods to expand their output in the short run when the profit/price incentive is strong enough. Although, due to the fact that various constraints make it expensive to promptly increase output, it may in fact require large increases in the price to evoke short term increases of the supply quantity.

Likewise with demand, supply has a similar scenario when it comes to durable goods. For certain goods, supply is more elastic in the short run. This is because these durable goods, they can be recycled as part of supply if and when price goes up. Scrap metal is a good example of this as it can be melted down and refabricated. So say the price of copper falls, the incentive to convert it into new supply is less than before. Initially, its supply drops quickly but then as the stock of it falls, the refabricating becomes more expensive for the producer and so it then rises again slowly. Therefore the short run elasticity is larger than the long run.

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