Cost in Short Run and Long Run (With Diagram)
The graph below shows Short-run cost output relationship. In the graph . Only short run is explained I need both short and long. ReplyDelete. So long as MC is above AVC, each additional unit of output adds more to total Summary of the Main Points All the important short-run cost relations may now. 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.
The shape of average fixed cost curve becomes rectangular hyperbola with the increase in output. It is calculated from the following formula: The average variable cost is total variable cost divided by the volume of output. Average variable cost falls with the increase in output, reaches at its minimum and then starts rising.
By the operation of law of increasing returns the AVC decreases, and by the operation of constant returns leads to constancy in AVC and the law of diminishing returns leads to increase in AVC. The shape of AVC is U-shaped because of the operation of the laws of returns during short period. The AVC is calculated by the formula given below: The following is the formula of calculating AC: Another formula for the calculation of AC is as given under: Its shape is U-shaped because of the operation of the laws of return during short period.
It is an addition to total cost by producing an additional unit of output. It can be calculated as the change in total cost divided by an additional unit change in the output.
The formula for its calculation is as given below: For example, if the total cost TC of 5 units of a commodity is Rs. It can be calculated on the basis of the above formula as given under: In the beginning the MC falls, reaches at its minimum and thereafter continuously rises.
MC is also U- shaped. The cost-output relation during short period can be seen from Table 2. AFC is decreasing, but it is positive. AVC decreases, remains constant and thereafter increases. AC also decreases, remains constant and shows an increasing trend. MC increases, remains constant and thereafter shows an increasing trend. On the basis of the Table 2 we can show the costs and output relation during short period in the following diagram: The U-shaped curves are on account of the operation of the laws of return during short period.
AFC curve shows a decreasing trend. There is a close relationship between AC and MC as given below: The MC curve cuts the AC curve at its minimum point.
The relation between AC and MC can be seen from the following diagram during short period: Long period gives sufficient time to business managers to change even the scale of production. 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. 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.
Cost Output Relation: Long and Short Run | Microeconomics
Exactly the same reasoning would apply to show MC crosses ATC at the minimum point of the latter curve. 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. 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.
Cost Output Relation: Long and Short Run | Microeconomics
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. Column 4 shows the total cost of producing each level of output at the lowest possible cost.