Cost in Short Run and Long Run (With Diagram)
Cost Output Relation: Long and Short Run | Microeconomics. Article shared by: In this article we will discuss about the cost-output relation during long run and. Considering the period the cost function can be classified as (1) short-run cost function and (2) long-run cost function. In economics theory, the. In this article we will discuss about Cost in Short Run and Long Run. This curve indicates the firm's total cost of production for each level of output when the usage of . Thus, it is clear that MC refers to MVC and has no relation to fixed cost.
But AVC curve i. If the rise in variable cost is less than the decline in fixed cost, ATC will still continue to decline otherwise AC begins to rise. Cost-output Relationship in the Long-Run Long run is a period, during which all inputs are variable including the one, which are fixes in the short-run. In the long run a firm can change its output according to its demand. Over a long period, the size of the plant can be changed, unwanted buildings can be sold staff can be increased or reduced.
The long run enables the firms to expand and scale of their operation by bringing or purchasing larger quantities of all the inputs. Thus in the long run all factors become variable. The long-run cost-output relations therefore imply the relationship between the total cost and the total output.
We also see that variable cost first increase at a decreasing rate the slope of STC decreases then increase at an increasing rate the slope of STC increases. This cost structure is accounted for by the law of Variable Proportions.
Average and Marginal Cost: We may first consider average fixed cost AFC. Average fixed cost is total fixed cost divided by output, i. Average fixed cost is relatively high at very low output levels. However, with gradual increase in output, AFC continues to fall as output increases, approaching zero as output becomes very large. The next important concept is one of average total cost ATC. It is calculated by dividing total cost by output, It is, therefore, the sum of average fixed cost and average variable cost.
It first declines, reaches a minimum at Q3 units of output and subsequently rises. This point can easily be proved.
Since AFC declines over the entire range of output. We may finally consider short-run marginal cost SMC. Marginal cost is the change in short-run total cost attributable to an extra unit of output: Thus average variable cost has to fall.
Thus, in this case, AVC must rise. Exactly the same reasoning would apply to show MC crosses ATC at the minimum point of the latter curve.Cost Analysis-2 Short-run Cost-Output Relationship in Hindi
Summary of the Main Points All the important short-run cost relations may now be summed up: The total cost function may be expressed as: Hence the AFC curve is a rectangular hyperbola.
Since business decisions are largely governed by marginal cost, and marginal costs have no relation to fixed cost, it logically follows costs do not affect business decisions. Relation between MC and AC: There is a close relation between MC and AC.
This can be proved as follows: When AC is falling, c.
On the basis of the relation between MC and AC we can develop a new concept, viz. It measures the responsiveness of total cost to a small change in the level of output. It can be expressed as: So it is the ratio of MC to AC. From the diagram the following relationships can be discovered.
These two concepts will be discussed in the context of market structure and pricing. Column 5 shows that average fixed cost decreases over the entire range of output.
Long and short run cost functions
Instead, the long run simply refers to a period of time during which all inputs can be varied. In order to be able to make this decision the manager must have knowledge about the cost of producing each relevant level of output. We shall now discover how to determine these long-run costs.
For the sake of analytical simplicity, we may assume that the firm uses only two variable factors, labour and capital, that cost Rs. The characteristics of a derived expansion path are shown in Columns 1, 2 and 3 of Table In column 1 we see seven output levels and in Columns 2 and 3 we see the optimal combinations of labour and capital respectively for each level of output, at the existing factor prices.
These combinations enable us to locate seven points on the expansion path. Total cost is the actual money spent to produce a particular quantity of output. But the Total Variable Cost i. Average cost is the total cost per unit. It can be found out as follows. Marginal Cost is the addition to the total cost due to the production of an additional unit of product.
It can be arrived at by dividing the change in total cost by the change in total output. In the short-run there will not be any change in Total Fixed C0st.
Hence change in total cost implies change in Total Variable Cost only. The table is prepared on the basis of the law of diminishing marginal returns. The fixed cost Rs.
Cost in Short Run and Long Run (With Diagram)
The table shows that fixed cost is same at all levels of output but the average fixed cost, i. The expenditure on the variable factors TVC is at different rate. If more and more units are produced with a given physical capacity the AVC will fall initially, as per the table declining up to 3 rd unit, and being constant up to 4th unit and then rising.
But the rise in AC is felt only after the start rising. Thus the table shows an increasing returns or diminishing cost in the first stage and diminishing returns or diminishing cost in the second stage and followed by diminishing returns or increasing cost in the third stage.
The short-run cost-output relationship can be shown graphically as follows.
But AVC curve i. If the rise in variable cost is less than the decline in fixed cost, ATC will still continue to decline otherwise AC begins to rise. Cost-output Relationship in the Long-Run Long run is a period, during which all inputs are variable including the one, which are fixes in the short-run.
In the long run a firm can change its output according to its demand. Over a long period, the size of the plant can be changed, unwanted buildings can be sold staff can be increased or reduced. The long run enables the firms to expand and scale of their operation by bringing or purchasing larger quantities of all the inputs. Thus in the long run all factors become variable. The long-run cost-output relations therefore imply the relationship between the total cost and the total output.
In the long-run cost-output relationship is influenced by the law of returns to scale. In the long run a firm has a number of alternatives in regards to the scale of operations. For each scale of production or plant size, the firm has an appropriate short-run average cost curves. The short-run average cost SAC curve applies to only one plant whereas the long-run average cost LAC curve takes in to consideration many plants.
It does not mean that the OQ production is not possible with small plant. Rather it implies that cost of production will be more with small plant compared to the medium plant. It is also known as planning curve as it serves as guide to the entrepreneur in his planning to expand the production in future.