Cost output relationship in short and long period

Cost-Output Relationship | spoorthi patil -

cost output relationship in short and long period

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. economics theory, the short-run is defined as that period during which the Cost -output Relationship in the Long-Run Long run is a period. It is not be the. TFC remains the same throughout the period and is not influenced by the level of activity. The firm will The graph below shows Short-run cost output relationship. . Only short run is explained I need both short and long.

Examples are electricity tariff, wages and compensation of casual workers, cost of raw materials etc. Clearly, variable cost and, therefore, total cost must increase with an increase in 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.

Short Run Costs ATC AVC AFC & MC Garphic Approach -

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.

cost output relationship in short and long period

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. 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.

cost output relationship in short and long period

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.

Explain the cost - output relationship in the short period and long period

It can be expressed as: So it is the ratio of MC to AC. From the diagram the following relationships can be discovered.

cost output relationship in short and long period

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.

Management Time: Description of Cost-Output Relationship : Managerial Economics

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.

cost output relationship in short and long period

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.

Column 4 shows the total cost of producing each level of output at the lowest possible cost. For example, for producing units of output, the least cost combination of inputs is 20 units of labour and 10 of capital. At existing factor prices, the total cost is Rs.

Here, Column 4 is a least-cost schedule for various levels of production. In Column 5we show average cost which is obtained by dividing total cost figures of Column 4 by the corresponding output figures of Column 1. Thus, when output isaverage cost is Rs. All other figures of Column 5 are derived in a similar way. From column 5 we derive an important characteristic of long-run average cost: In Column 6 we show long-run marginal cost figures.

Each such figure is arrived at by dividing change in total cost by change in output. For example, when output increases from Rs. Therefore, marginal cost per unit is Rs. We may now show the relationship between the expansion path and long-run cost graphically. Finally, the known production function gives us the isoquant map, represented by Q1, Q2 and so forth.

We may now relate this expansion path to a long-run total cost LRTC curve. For example, in Fig. Every other point on LRTC is derived in a similar way. Thus, totally different production processes may be used to produce say Q 1 and Q2 units of output at the lowest attainable cost. 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. Cost-Output Relationship pptx Related Articles: