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Introduction:
Short-run cost is the price of a product that has short-term implications in the production process, i.e., it is used across a limited number of end products. These are the costs that are made only once and cannot be recovered, such as wages, raw material costs, electricity bills and so on. In the short run, there exists both fixed as well as variable costs.
For example- Let’s say a firm notice a sudden rise in demand for caps and it realises that the only way to meet the additional demand in the short run is to change the temporary elements, like, the firm can hire more labours or buy raw materials in bulk, but the plant size or machinery cannot be changed to increase the firm’s production capacity of caps. As a result, the short-run cost includes all costs expended on variable components such as labour and raw materials.
The short-run cost varies with the change in total output from an analytical standpoint, while the firm’s size remains constant. As a result, the short-run cost is always considered a variable cost.
What is Cost?
The expenditure made by the producer on factors of production is called the cost of production.
Types of short-run cost
- Short-run total cost
- Short-run average cost
- Short-run marginal cost
Short-Run Total Cost:
The total cost is the real cost that a firm incurs to produce a certain level of output. An organisation’s Short-Run Total Cost (SRTC) is made up of two cost- TFC and TVC:
Total Fixed Costs (TFC):
These costs are constant regardless of production. Whether a firm produces an output or not, TFC remains constant. It is a straight horizontal line parallel to the x-axis.
Total Variable Cost (TVC):
These costs are proportionate to a firm’s output. As output rises, TVC rises, and as output declines, TVC also declines. The SRTC is calculated by adding fixed and variable costs.
SRTC=TFC+TVC
Short-Run Average Cost:
The average cost is determined by dividing the total cost by the number of units produced by a firm. The short-run average cost (SRAC) of a firm refers to the per-unit cost of output. To compute SRAC, the short-run total cost is divided by the output.
SRAC = SRTC/Q = TFC + TVC/Q
Where, TFC/Q =Average Fixed Cost (AFC)
and TVC/Q =Average Variable Cost (AVC)
Therefore, SRAC = AFC + AVC
A firm’s SRAC is U-shaped. It begins to drop, reaches a minimum, and then begins to rise.
Short-Run Marginal Cost:
The change in a firm’s total cost divided by the change in total output is known as marginal cost (MC).
The change in short-run total cost owing to a change in the firm’s output is referred to as short-run marginal cost.
SRMC = ∅SRTC / ∅Q
The marginal cost of a firm is used to decide whether or not more units should be produced. If a firm could sell the additional unit at a price greater than the cost incurred to create the additional unit (marginal cost), the firm may elect to produce the additional unit.
QUANTITY | FIXED COST | TOTAL VARIABLE COST | TOTAL COST | AVERAGE COST | MARGINAL COST |
10 | 5 | 8 | 13 | 1.3 | – |
11 | 5 | 15 | 20 | 1.8 | 7 |
12 | 5 | 5 | 10 | 0.8 | 10 |
13 | 5 | 2 | 7 | 0.5 | 3 |
Because of increasing returns at first and then diminishing returns, the short-run marginal cost (SRMC), the short-run average cost (SRAC), and average variable cost (AVC) are all U-shaped.
Long-Run Cost:
The long-run cost is a cost in the production process that has long-term repercussions, i.e.; it is spread over a wide range of output. These costs are incurred on fixed factors of production, such as plant, building, and machinery.
As the firm’s size of production grows, even fixed costs become variable costs in the long run. Entrepreneurship, land, labour, capital goods, and other factors all change over time to achieve the desired level of profits, and the cost of each item contributes to the long-run costs.
Cost-Output Relationship in the Short Run
Average Fixed Cost Output:
The larger the output, the lower the fixed cost per unit (average fixed cost). The reason for this is that overall fixed costs stay constant regardless of output. The average fixed cost falls as output rises
Average Variable Cost and Output:
At first, the average variable costs will fall and then rise as more units are produced in a firm. This is because, as additional units of variable components are added to a fixed factor, , the efficiency of the inputs initially rises, then falls.
However, once the optimum capacity is reached, any further increase in output will result in a significant increase in average variable cost. Greater output is possible, but it comes at a far higher average variable cost.
Average Total Cost and Output:
The average total cost will firstly decline and then rise upward. The average cost is made up of the average fixed and variable costs. As we can see, average fixed costs continue to shrink as output rises, whereas average variable costs first fall and then increase.
The average total cost will decrease as long as the average variable cost decreases. However, beyond a certain point, the average variable cost will begin to increase. The lowest cost-output level is the level where the average total cost is the minimum and not the average variable cost. The optimum output level is also the lowest cost-output level.
Conclusion:
In the short-run, the average fixed cost is always higher than the average variable cost. The reason behind this phenomenon is inefficiency-the average fixed cost is large because inefficiencies arise within fixed costs. As a result, if an efficient firm were to produce an output that is lower than some point at which the average fixed cost equals the average variable cost, it will give up on producing that amount of output and keep producing at a level where the average total cost equals zero. This phenomenon is known as break-even point or long run equalisation of average costs.
