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.
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.
Long Run Cost (LRC) can be divided into three primary types:
The minimum cost required to produce a particular quantity of commodity with variable factors of production is LTC.
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.
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.
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.
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
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
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.
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 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.
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.
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.
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.
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.
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…
Investments
What is Sortino Ratio – Formula and Calculations with Examples
Sortino ratio is a statistical tool that helps measure an investment’s performance during a downw... Read More »Investments
What is Forfaiting – Benefits and Process with Steps
Forfaiting is a financial process involving the management of finance exports. It aids businesses b... Read More »Investments
EPF Interest Rate 2022-23
Employee Provident Fund or EPF has been popular among salaried individuals for a long time now. It ... Read More »Investments
How to Open, Transfer or Close a PPF Account: Eligibility and Documents
PPF (Public Provident Fund) investments come with many benefits. You get to enjoy assured returns, ... Read More »Investments
What is an Affidavit – Features, Types, Format and Sample
An affidavit is a sworn written statement, made especially under affirmation or oath befo... Read More »Investments
What is Employee Stock Ownership Plan (ESOP): Scheme, Benefits, Taxation and Types
Most Indian companies, especially startups, offer a plethora of employee benefit plans in a bid to ... Read More »Investments
Sukanya Samriddhi Yojana: Bank Interest Rates and How to Open One?
Honourable Prime Minister Narendra Modi launched Sukanya Samriddhi Yojana as an important part of t... Read More »Investments
What is a Prospectus – Working, Types and Use in Mutual Funds
A prospectus is a legal document disclosing information regarding a public company seeking to raise... Read More »Investments
A Step-by-Step Guide to UAN Generation and Activation Process
The Employee Provident Fund Organisation (EPFO) assigns a unique 12-digit number or UAN (Universal ... Read More »Investments
EPF Vs PPF – Difference, Taxation and Where to Invest
Employees Provident Fund (EPF) and Public Provident Fund (PPF) are two of the most popular long-ter... Read More »Investments
What is Systematic Risk and How can an Investor Control?
Systematic risk refers to the inherent uncertainty that is present in all investments and is not sp... Read More »Investments
6 Different Types of ESOPs – Employee Stock Ownership Plans
Employee Stock Ownership Plans, or ESOPs, are a type of equity financing that allows employees to o... Read More »Mutual Funds
Top 10 Chit Fund Schemes in India in 2023
Chit funds are one of the most popular return-generating saving schemes in India. It is a financial... Read More »Personal Loans
₹15,000 Personal Loan: Features, Benefits, EMI and Interest Rate
Financial emergencies can be short term and you might not always require a large amount to handle t... Read More »Personal Loans
Personal Loan Interest Rates in India – Charges and Processing Fee
Applying for a personal loan? Have you compared the personal interest rates and processing fees? ... Read More »Mutual Funds
10 Best Gold ETFs to Invest in India [2023]
Gold ETFs or Gold Exchange Traded Funds are passively managed funds that track the price of physica... Read More »Health Insurance
TPA in Health Insurance – Full Form, Functions and Roles
TPA (full form – Third Party Administrator) is a licensed intermediary between health insurance p... Read More »Banking
ATM Card AMC (Annual Maintenance Charge): Explained
ATM Card AMC (Annual Maintenance Charge) is a maintenance fee levied by banks every year. This debi... Read More »Mutual Funds
Top 10 Demat Accounts in India [Lowest Brokerage Charges]
A Demat account was created to eliminate the time-consuming and inconvenient procedure of purchasin... Read More »Mutual Funds
20 Best Index Funds in India to Invest in 2023 (27th Jan)
What is an Index Fund? An index fund is a type of mutual fund or exchange-traded fund (ETF) that... Read More »All information is subject to specific conditions | © 2023 Navi Technologies Ltd. All rights are reserved.
Start Small. Dream Big.
Start your Investment Journey with just ₹10