Economics

The Nature of Cost in Long Run and Short Run

Group number : 6

Rahul Khullar(35)
Rajat Kumar(36)
Ravi kr. Bajaj(37)
Rimit(38)
Saba Khan(40)
Income and Costs

The firm's income is total revenue TR.

The firm's profits are total revenue minus
costs = TR - costs.
◦ The firm's costs are the money it spends.
◦ Firms try to minimize costs without adversely
affecting the quality of their products.
◦ Firms vary the mix of inputs they use until they
find the lowest‑cost way to produce their product.
Cost and Types of Costs :
A Cost is the value of money that has
been used up to produce something or
provide a service.

Types :
◦ Long run costs
◦ Short run costs
What is Short Run
Cost??
Short Run Costs
In the short run, because at least one
factor of production is fixed, output can
be increased only by adding
more variable factors. Hence we
consider both fixed and variable costs.

Therefore
the cost will be
TC = TFC+TVC
Short-Run Costs

In the short run, the firm has two types of

costs:
Fixed cost: the cost of the production
facility, which is independent of the amount
of output produced in it.
Variable costs: the costs of labor and
materials associated with producing output.
 Short-run Total Cost

Output:
Rakes per Fixed
Total TC  TFC  TVC
Short-run
Variable Short-run Marginal
Total Total
Minute Cost Cost Total Cost Total
Cost
Cost = Fixed + Variable
Q FC TVC STC SMC Cost Cost
0 36 0 36 -
1 36 8 44 8 Total Costs
150
2 36 12 48 4
3 36 15 51 3
4 36 20 56 5100

Cost in $
5 36 27 63 7
6 36 36 72 950
7 36 48 84 12
8 36 65 101 17
0
9 36 90 126 25 0 1 2 3 4 5 6 7 8 9 10 11
10 36 130 166 40 Output: Rakes per minute
Short-Run Average Total Cost
 Short-run average total cost measures total cost per unit
of output produced.

TFC TVC
SATC  
Q Q
Short-run Fixed Variable
Average = Cost per + Cost per
Total Cost Unit Unit

SATC  AFC  SAVC

Short-run Marginal Cost

Short-run marginal cost is the change

in total cost resulting from a One-unit
increase in the output of an existing
production facility.

TC
M C 
Q
 Diminishing Returns and Increasing
Marginal Cost

The marginal cost of production is the amount of

money necessary to buy the additional labor and
materials necessary to produce one more unit of
output.
The marginal cost of production increases because
output increases at a decreasing rate with additional
labor hours.
 Short-run Average and Marginal Costs:
An Example
Per-unit costs
Output: Short-run Average Short-run Short-run
40
Rakes per Marginal Fixed Average Average
Minute Cost Cost Variable Cost Total Cost 35

Q SMC AFC SAVC SATC 30

0 - - - - 25

Cost in $
1 8 36.00 8.00 44.00 20
2 4 18.00 6.00 24.00
15
3 3 12.00 5.00 17.00
10
4 5 9.00 5.00 14.00
5 7 7.20 5.40 12.60 5
6 9 6.00 6.00 12.00 0
7 12 5.14 6.86 12.00 0 1 2 3 4 5 6 7 8 9 10 11
8 17 4.50 8.13 12.63 Output: Rakes per minute
9 25 4.00 10.00 14.00
MC ATC AFC AVC
10 40 3.60 13.00 16.60
Average Total Cost is the Sum of Average
Variable and Average Fixed Cost

Average Average Average

Quantity
Produced Total Fixed Variable
Cost ($) Cost ($) Cost ($)
100 90 72 18
300 58 24 34
400 68 18 50

 The gap between SATC and SAVC

decreases as output increases.
 AFC continuously decreases as total
fixed cost is spread over more units
of output produced.
Short-run Average Total Cost (SATC)

 TheSATC curve is U-
shaped because of the
behavior of its two
components as output
produced increases.
◦ AFC decreases as output
increases.
◦ SAVC increases as
output increases.
Relationship between Short-run Marginal
and Average Cost Curves
As long as SATC is
declining, marginal cost
lies below it.
 When SATC rises, SMC
is greater than SATC.

 At point m, SATC=SMC.
Relationship between Short-run Marginal
and Average Cost Curves
Marginal Average
Quantity
Cost Total Cost
Produced
($) ($)
100 26 90

300 58 58
400 90 68

 The marginal cost curve (SMC)

intersects the average cost curve
(SATC) when average cost is
minimum.
What is Long Run
Cost??
Long‑Run Cost Curves
Production and Cost in the Long Run

The key difference between the short run and the long
run is that there are no diminishing returns in the long
run.

Diminishing returns occur because workers share a

fixed facility. In the long run the firm can expand its
production facility as its workforce grows.
 Long-run Average Cost
Long-run average cost (LAC) is total cost
divided by the quantity of output when the firm
can choose a production facility of any size.
The LAC curve describes the behavior of average
cost as the plant size expands. Initially, the curve
is negatively sloped, then beyond some point, it
becomes horizontal.
Long Run Average Cost Curves and Their Slope

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A Typical Long-Run Average Total Cost Curve
Costs per
unit
$60 Long-run
average total
Minimum cost (LRATC)
efficient level
$55 of production

$50

Q
11 14 17 20
ATC falls because of ATC is constant ATC rises because of
economies of because of constant diseconomies of
scale returns to scale scale
Long-Run and
Short-Run Cost Curves
Labor Specialization

Ina large operation, each worker specializes in

fewer tasks thus is more productive than his or her
counterpart in a small operation.
Higher productivity (more output per worker)
means lower labor costs per unit of output, thus
lower production costs (ever-decreasing average
cost).
Determinants of the Shape of the Long-
Run Cost Curve

The shape of the long-run cost curve is

due to the existence of economies and
diseconomies of scale.
Economies of Scale
 Economies of scale: a situation in which an increase in
the quantity produced decreases the long-run average cost
of production.
 Economies of scale refer to cost savings associated with
spreading the cost of indivisible inputs and input
specialization.
 When economies of scale are present, the LAC curve will
be negatively sloped.
Minimum Efficient Scale
The minimum efficient scale describes the output
at which economies of scale are exhausted and the
long-run average cost curve becomes horizontal.
Once the minimum efficient scale has been
reached, an increase in output no longer decreases
the long-run average cost.
Diseconomies of Scale
A firm experiences diseconomies of scale when
an increase in output leads to an increase in long-
run average cost—the LAC curve becomes
positively sloped.
Diseconomies of scale may arise for two reasons:
◦ Coordination problems
◦ Increasing input costs
Examples of Economies of Scale
LAC Curve for Electricity Generation LAC Curve for Aluminum Production
The Difference between the Short Run
and the Long Run

The short run is a time period during

which some inputs are fixed.
The long run is a time period during
which no inputs are fixed; all inputs can
be changed.

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