Short Run & Long Run Costs
the economist prefers to look at how the resource is contributing to creating value,
rather than at arbitrary accounting rules and tax laws.
Diseconomies of scale occur when input is greater than output,
resulting in reduced cost-efficiency and lower profits.
Increasing the scale of the production process gives proportionately more output.
Economies of scale
Economists are concerned with
economic profit.
When economists measure profit, they take into account all the
explicit costs and the implicit costs involved in producing goods and services.
The short run is the time frame in which the quantities of some resources are
fixed, or assumed to be constant.
Long-run average cost curve, by:
By opening a duplicate of the existing equipment and hiring more workers at another site
occur when a given percentage increase in the plant size and labor employed results in the same percentage increase in output and the same average cost per unit.
Constant Returns to Scale
Output increases in a direct proportion to the scale of the production process.
Constant returns to scale
A curve that shows the lowest average cost at which it is possible to produce each output when the firm has had sufficient time to change both its plant size and labor employed.
Long-run average cost curve
Better equipment often reduces costs and increases output, lowering average cost per unit.
Specialization of capital
Specialization of labor, average product of labor increases
and the average total cost decreases.
In the short run, some factors of production cannot be changed. Investments in land, buildings, and equipment
extend beyond the current period of production, and we consider them fixed in the short run.
Most costs incurred in the short run are
fixed, such as rent, utilities, and salaries.
average product (AP) increases as long as the marginal product (MP) of an additional worker
is greater than the average product per worker
The highest valued alternative foregone
is the opportunity cost of a company's production
Average fixed cost is
total fixed cost per unit of output
Total costs can be measured by adding
total fixed costs and total variable costs.
The value of plant and equipment is very much dependent on its intended use,
usually so dependent that investments in many fixed assets are considered irreversible.
In the short run, output is increased or decreased by
varying the quantity of variable productive resources.
Adding total fixed costs (TFC) and total variable costs (TVC)
we have total costs (TC)
Output can also increase proportionally with input, or constant returns to scale,
which results in increased production.
Increasing the scale of the production process gives proportionately less output.
Diseconomies of scale
Long-run average cost curve, by:
Expanding production by investing in new equipment or adding more space
dividing up the process into specialized tasks allows workers to become more skilled at their particular duties, and more productive
Specialization of labor
If a company has already optimized its production process to achieve the lowest possible average cost per unit,
adding capacity might result in less efficiency and higher average costs
short-run costs
are fixed,
long-run costs
are variable
Money spent to increase long-run production is referred to as sunk costs
because the investments are so large that they are irreversible
Explicit costs are those costs that can be readily identified
because they are paid in money.
To measure profit, a business needs to track its opportunity costs—
both explicit such as money laid out for expenses and implicit such as depreciation, capital, and labor.
Variable costs increase with output,
but initially they increase at a lessening rate (slope), which is reflected in variable costs (labor), which do not increase as fast as output
The costs of adding to plant capacity are relevant to long-run decisions,
but maximizing profit in the short run focuses on variable costs, such as labor.
Over the long term, costs are subject to more variables such as
changes in supply or demand or price increases.
If input and output increase proportionally, the result is
constant returns to scale, which can double production
Since short-run production is
for a set period, ostensibly there will not be enough time for costs to change significantly.
Implicit costs are those that involve a factor of production
for which the company does not make a money payment.
Total product is the quantity of goods produced
in a given time period.
The change in total cost that results from an increase of one unit of output
is defined as the marginal cost.
Marginal product is the change in total product that results from a
one-unit increase in the quantity of a factor of production
Diseconomies of scale occur when
output increases less than input
The long run is defined as the time frame in which
quantities of all productive resources can be varied
Fixed costs are generally examined in
short-run planning.
Longer-term costs can also include large investments
such as the costs involved in building a new facility.
Long-run production is more subject to any number of changes in
supply, demand, or related factors that can affect costs
Economists prefer to consider economic depreciation,
the change in market value of the capital asset for fixed assets, and the market interest rates for the cost of funds
any production process adds a single variable factor of production to a given quantity of fixed factors of production, the marginal product of the variable factor eventually decreases
the law of diminishing returns
When output is greater than input,
the result is what economists call economies of scale.
Economists focus on opportunity costs,
the value of the next best alternative use of a scarce resource