Understanding Long Run and Short Run Costs in Business
Production costs of any business helps determine returns and scope of expansion. Several elements that contribute to the production cost vary from company to company. These factors can be fixed or variable depending on the production’s time period and output scale. Short run and long run costs determine production efficiency and help to understand how to improve the operational costs of an organisation.
Read on to learn the different types of long and short run costs.
What is Long Run Cost?
Long Run Cost is the minimum cost at which a certain level of output can be achieved in the long run when all factors of production are variable.
These costs enable a business to understand its asset value and make necessary improvements in the production cycle. As a result, this helps organisations analyse their factors of production and expand or reduce their operational costs accordingly.
What are the Types of Long Run Costs?
Long Run Cost (LRC) can be divided into three primary types:
• Long Run Total Cost (LTC)
The minimum cost required to produce a particular quantity of commodity with variable factors of production is LTC.
• Long Run Average Cost (LAC)
LAC can be described as the average cost to produce a particular quantity of commodity when all factors of production are variable. It is the LTC divided by output level, which derives a per-piece cost of the total output.
• Long Run Marginal Cost (LMC)
It depicts the additional costs a company incurs to expand its factors of production when all units are variable. LMC is the extra cost of expanding a plant or facility.
Also Read
What is Long Run Total Cost Curve?
A long run total cost curve (LRTC) is a graph representing the total cost of production of a certain unit and its relation with the average cost. It is an S-shaped curve with total cost on one axis and the produced quantity on the other axis.
In the image below, you can see the representation of an LTC Curve.
What is Long Run Average Cost Curve?
Long run average cost curve (LRAC) is a graph representing a company’s average cost with an increase in the number of units for a fixed output. It is a U-shaped curve determining the relation between the output and the average cost incurred. As the LAC first decreases and then increases, the graph forms a U-shape.
Here is an example that illustrates the LRAC:
Image Source: https://d1whtlypfis84e.cloudfront.net/guides/wp-content/uploads/2018/09/04154002/LRACC2.jpg
What is Long Run Marginal Cost Curve?
Long run marginal cost curve (LRMC) is a graph representing the increase in marginal cost with an expansion of production scale. It helps to determine the changes in the cost of production of a company. Similar to LRAC, it is also a U-shaped curve.
Here is an example of a Long Run Marginal Cost Curve:
Image Source: https://encrypted-tbn0.gstatic.com/images?q=tbn:ANd9GcQC6QLnBTWuBEdgJwRb6AMViDl0par4Y9Ynrg&usqp=CAU
What are Short Run Costs?
It is the cost incurred in production during a fixed period of time when all the factors and inputs vary, except one. Assessing the short run costs of an organisation or an economy helps us to study how it behaves in response to sudden environment changes.
What are the Types of Short Run Costs?
There are primarily three types of short run costs. It should be kept in mind that these costs are crucial to determine the long run costs of a company.
• Short Run Total Cost (STC)
Short run total cost is a company’s total cost of production for a given output. It is further divided into two types which are total fixed and variable costs. The total sum of these two elements determines the STC.
- Total variable costs (TVC) are costs that change when the output changes in the short run, like cost of raw materials.
- Total fixed costs (TFC) are costs that remain the same with an increase in production in the short run, like the cost of machinery.
• Short Run Average Cost (SAC)
SAC is the average cost of a given production of a company in the short run. It is the average cost per unit when all inputs are variable except one. Short run total cost divided by output equals SAC.
• Short Run Marginal Cost (SMC)
It is the additional cost incurred to produce a certain output. SMC is incurred when there is a change in total cost due to a change in production input costs. It is calculated by dividing the total cost by change in total output.
Also Read
Relationship Between Long Run and Short Run Costs
Both short run and long run cost curves are essential economic tools to assess the cost of production of an organisation. This, in turn, helps to develop a more efficient production process and improve profitability.
Although these two costs are quite closely dependent on each other, they have their own share of differences.
- LRCs are calculated for an extended period of time, and hence all factors of production are variable. However, SRC affects the long run production costs as it is the average cost that gets added to the LRC of a production unit.
- In the long run, the fixed factors of SRC also turn into variables that affect the SAC individually.
Final Word
Long Run Cost determines the efficiency of a company’s production process and scale for expansion. In contrast, short run costs help to understand the performance of a company or an economy in a short time period.
Short and long run costs are effective tools of economics, essential to assess the cost of production process of an organisation. The various types of production costs are essential to calculate the profitability of a company.
FAQs on Long Run and Short Run Costs
Ans: Long run strategies are effective in reducing cost of production; however, they are not perfect. The risks of long run cost reduction strategies are:
• These strategies are not feasible for a long period of time.
• The strategies are constructed with the objective of short term goals.
• Long run strategies are tough to apply practically.
Ans: In long run cost, all the factors of production are variable, whereas, in the short run cost, at least one factor of production is fixed.
Ans: With the help of technology, companies can apply modern resources and methods to automate tasks, reduce labour costs and boost production process. Hence, technology plays a great role in improving the cost of production.
Ans: The short run cost can be divided into two parts: total variable cost (TVC) and total fixed cost (TFC). The total cost is the addition of these two parts. Thus, the formula for short run total cost is TVC+TFC.
Ans: No, all costs are variable in the long run. Over a long time period, a business can add several aspects to the production processes, which will have a significant impact on the costs. Thus, none of the costs are fixed in the long run.
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully. This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.Before you go…
