Long Run

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Long Run

CLASSICAL AND NEOCLASSICAL PERSPECTIVES

EXTENSIONS AND CRITICISM

BIBLIOGRAPHY

The term long run entered economic analysis as economists started considering different time horizons in their analyses. All the consequences of economic events may not occur immediately, nor may they all happen at the same time. The concepts of long and short run were thus introduced in order to cope with these problems. In a long-run context, all consequences are assumed to be finished, whereas in the short run only some effects are taken into account.

CLASSICAL AND NEOCLASSICAL PERSPECTIVES

The term was explicitly used for the first time in the works of the Cambridge economist Alfred Marshall (18421924), who detailed a concept of long-run equilibrium that became broadly accepted and used in the scientific community. Implicitly, the classical economists of the eighteenth century, Adam Smith (17231790) and David Ricardo (17721823), already used the concept of a longrun equilibrium, as did Karl Marx (18181883) after them. The former focused attention on so-called normal or long-period positions of the economy in conditions of free competition and the corresponding system of natural values and a uniform rate of profits. These natural values guarantee the payment of wages, profits, and rents so that no extra profits occur. In contrast, market values are the observed prices that are influenced by all sorts of factors, both systematic and accidental, persistent and temporary. Market values do not necessarily converge to their natural values but are considered to gravitate around their natural levels. Marx had a similar view on the long-run position of the economy. The classical economists determined the rate of profits and relative prices in terms of given levels of output, given technical alternatives, and a given wage rate (or share of wages).

The neoclassical economists of the nineteenth century and early twentieth century used a related methodology. Their theories attempted to determine prices, income distribution, and quantities simultaneously in terms of given endowments, technical alternatives, and preferences. Their works led to the elaboration of general equilibrium analysis, which, in contrast to partial equilibrium analysis, focuses on the economic system as a whole. Among the neoclassical economists, Marshall in Principles of Economics (1890) made a distinction between four different types of equilibria: temporary, short run, long run, and secular equilibrium. In temporary or very short run equilibrium, supply is fixed, and the price is solely determined by demand. In the short run, supply itself is not fixed, but the production is constrained by a given plant and equipment. As a consequence, productive capacity is given in a short run. In the long run, supply can adjust perfectly to demand via an adjustment of productive capacity within the prevailing production technology. Finally, in the secular or very long run, technical knowledge may change. Although neoclassical authors developed the tools for handling short-run problems, the long-run analysis remained dominant.

EXTENSIONS AND CRITICISM

John Maynard Keynes (18831946) called for focused attention on short-run problems with his witticism in A Tract on Monetary Reform : In the long run we are all dead (Keynes 1923, p. 65). An investigation of the impact of effective demand on output, given productive capacities, is at the center of Keyness magnum opus The General Theory of Employment, Interest, and Money (1936). His conclusion is that the demand side of the economy is of crucial importance not only in the short run but in the long run as well. This argument is studied in terms of income and employment multipliers, which originally were suggested by the British economist Richard Kahn (19051989), who augmented Marshalls distinction of long and short run with a classification as regards cost. In the short period, firms face fixed costs, and windfall profits or losses might occur. By contrast, costs are entirely variable in the long run because all factors of production become flexible, at least in principle. Companies can freely enter and exit industries, which leads to a uniform profit rate throughout the economy. Contrary to previous authors, the U.S. economist Milton Friedman (19122006) defined the long period with regard to adaptive expectations. In numerous works he investigated the effects of monetary policies and discovered that they were moderate in the short run and practically nil in the long. He maintained that there is no long-term trade-off between inflation and unemployment because of the influence of expectations regarding inflation on the behavior of forward-looking agents. Exogenous shocks can only affect the economy in the short run, whereas they have no influence in the long run. In contrast to Keynes, Friedman stated that the long run is determined entirely by supply-side conditions and effective demand does not matter. An even more radical point of view, based on the theory of rational expectations, was established by the U.S. economist Robert Lucas (b. 1937). In his contributions to the theory of endogenous growth, he argued that the economy would converge to a balanced path, irrespective of short-run perturbations. This balanced path is considered to be a close approximation to any actual development, and thus the attention should focus on it.

The different types of long-run equilibria mentioned are also known as stationary equilibria, steady states, and intertemporal equilibria. The relative importance of either long-run or short-run analysis has varied considerably over time. Whereas classical and neoclassical economists predominantly treated long-run problems, Keynes drew attention to the short run. In correspondence to the different problems at hand, the methods applied varied vastly, from micro to macro and from static to dynamic. A convincing unification of the long- and short-run points of view is not yet in sight. The time horizon and therefore the distinction between short and long run seem to remain crucial in economics.

SEE ALSO Exchange Value; Expectations; Friedman, Milton; Kahn, Richard F.; Keynes, John Maynard; Long Period Analysis; Lucas, Robert E., Jr.; Marshall, Alfred; Marx, Karl; Ricardo, David; Short Period; Short Run; Smith, Adam

BIBLIOGRAPHY

Garegnani, Pierangelo. 1976. On a Change in the Notion of Equilibrium in Recent Works on Value and Distribution. In Essays in Modern Capital Theory, ed. Murray Brown, Kazuo Sato, and Paul Zarembka, 2545. Amsterdam: North-Holland.

Keynes, John M. 1923. A Tract on Monetary Reform. London: Macmillan.

Keynes, John M. 1936. The General Theory of Employment, Interest, and Money. New York: Harcourt, Brace.

Kurz, Heinz D., and Neri Salvadori. 1998. Understanding Classical Economics: Studies in Long-period Theory. London: Routledge.

Marshall, Alfred. [1890] 1920. Principles of Economics. 8th ed. London: Macmillan.

Wolfgang Eichert

Rita Strohmaier

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