The economic concepts of the long run and the short run have become part of everyday language. Managerial economists are also concerned with the short-run and long-run effects of decisions on revenues as well as on costs. The actual problem in decision-making is to maintain the right balance between the long-run and short-run considerations. A decision may be made on the basis of short-run considerations, but may in the course of time offer long-run repercussions, which make it more or less profitable than it appeared at first.
An illustration will make this point clear.
Suppose there is a firm with temporary idle capacity. An order for 5,000 units comes to management’s attention. The customer is willing to pay 4.00 $ per unit or 20,000 $ for the whole lot but not more. The short-run incremental cost (ignoring the fixed cost) is only 3.00 $. Therefore, the contribution to overhead and profit is 1.00 $ per unit ( 5,000 $ for the lot. However, the long-run repercussions of the order ought to be taken into account are as follows:
- If the management commits itself with too much of business at lower prices or with a small contribution, it may not have sufficient capacity to take up business with higher contributions when the opportunity arises. The management may be compelled to consider the question of expansion of capacity and in such cases; even the so-called fixed costs may become variable.
- If any particular set of customers come to know about this low price, they may demand a similar low price. Such customers may complain of being treated unfairly and feel discriminated. In response, they may opt to patronize manufacturers with more decent views on pricing. The reduction or prices under conditions of excess capacity may adversely affect the image of the company in the minds of its clientele, which will in turn affect its sales.
It is, therefore, important to give due consideration to the time perspective. The principle of time perspective may be stated as under: “A decision should take into account both the short-run and long-run effects on revenues and costs and maintain the right balance between the long-run and short-run perspectives.”