CA Foundation Exam June 2023 » CA Foundation Study Material » Business Economics » Analysis of the Theory of Long Run Cost in Economics

# Analysis of the Theory of Long Run Cost in Economics

## Introduction

The long run denotes the time during which a company can change all of its production parameters. As a result, the long run only has variable inputs, and the idea of fixed inputs is absent. In the long run, the company can expand the plant’s size. Because fixed costs do not exist in the long run, there is no distinction between long-run variable cost and long-run total cost. The long run cost of manufacturing an item or service is determined by land, labour, capital goods, and entrepreneurship.

## Long run explanation

In general, the long run is when all expenses are variable. Because it is dependent on the details of each organisation, it is not a definite length of time. A company may develop new plants, buy new equipment, or shut down current ones. A company might examine different manufacturing technologies or processes when preparing for the long term. Technology refers to various techniques of integrating inputs to generate outputs in this sense. It isn’t a reference to a particularly new invention, such as the tablet computer. Firms look for production technologies that will allow them to generate the desired output at the least cost. After all, assuming overall sales stay constant, decreased expenses increase profits.

### Long Run Total Costs

The least cost of manufacturing, in the long run, is referred to as the long run total cost. It is the cheapest way to produce a certain amount of output. As a result, it can be less than or equal to the short run average costs at various production levels, but never higher. The minimum points of the Short run total cost curves at different output levels are linked visually to form the LTC curve. The LTC curve is the location of all these spots.

#### Long Run Average Cost Curve

The average of the Long Run Total Cost curve (LTC), or the cost per unit of production, in the long run, is known as the long run average cost (LAC). It may be determined by dividing LTC by the output quantity. The Short Run Average Cost (SAC) curves may calculate LAC graphically.

The SAC curves apply to a specific plant since the plant is fixed in the short term, but the LAC curve illustrates the potential for plant development while limiting costs.

Long Run Cost Curves: Total Cost, Average Costs, and Marginal Cost

The best option is to produce at the smallest plant size possible in the long term. This results in a LAC curve that connects the minimum points of all feasible SAC curves. As a result, the LAC curve is an envelope or planning curve. The curve lowers at first, then reaches a minimum before rising again, forming a U-shape.

Returns to scale can describe the form of the LAC curve. Returns to scale show how output changes in response to changes in inputs. When employing fewer than double inputs, the output doubles over Increasing Returns to Scale (IRS). So, LTC grows slower than production, and LAC decreases.

In Constant Returns to Scale (CRS), the outputs get doubled when the inputs are doubled, and the LTC rises in lockstep with the output growth. As a result, LAC does not change.

In DRS (Decreasing Returns to Scale), the output gets doubled while the inputs are more than doubled, causing the LTC to climb more than proportionally to the growth in output. As a result, LAC increases. The U-shape of LAC is due to this.

#### Long Run Marginal Cost

The additional cost of creating an extra unit of output in the long run, i.e., when all inputs are variable, is known as long run marginal cost. The tangent point between SAC and LAC creates the LMC curve.

Shifting Patterns of Long-Run Average Cost

Breakthroughs in manufacturing technology can modify the size distribution of enterprises in an industry by shifting the long-run average cost curve. In recent days, the most typical shift has been technological advancements, such as the assembly line or the giant department store, which appeared to give large-scale companies an edge over smaller ones.

## Conclusion

For producers, the long run is a stage of management and execution. To make manufacturing decisions, they examine the existing and forecast situation of the market. Long run cost efficiency is achieved when a company’s outputs are combined to generate the necessary amount at the lowest possible cost. Changing the amount of production, shrinking or growing a company, and joining or exiting a market are all examples of long-run actions that affect a firm’s expenses.

Get answers to the most common queries related to the CA Foundation Examination Preparation.

## · Why is the Long run Average Cost curve also called the envelope curve?

Ans: The LAC curve indicates the firm’s long-run optimization dilemma. T...Read full

## · How can a firm reduce long run costs?

Ans: Firms can pick their manufacturing technology in the long term, making al...Read full

## · What is the difference between the short run and long run cost?

Ans: The significant distinction between the short run and long run ...Read full

## What are some examples of long run costs?

Ans: Economists define long-run or fixed costs, including land and capital. Sh...Read full