Short run costs

Short-run costs refer to a period where, with the exception of one input, all other inputs are variable. The short-run here is not representative of a specific period. Instead, depending on the industry, firm, or economic variable under study, this duration will vary.

Studying short-run costs helps us observe how a particular economy behaves. How it behaves in response to certain stimuli in the environment varies according to the time it has to absorb and react accordingly. 

What are short-run costs?

Short-run costs refer to a period where at least one input is fixed. All other inputs are variable. During this period, only certain variables can be changed. 

Only variable costs can change according to the level of output. This includes: 

• Employee wages
• Raw material

Fixed factors of production remain the same. These are:

• Plants 
• Equipment
• Factory buildings
• Capital

Even though both fixed and variable costs are encountered, only the latter can be changed. Equilibrium – a point in time when opposing forces are completely balanced – is not possible. Costs on one side will always be higher in the short run.  

Types of short-run cost

There are three types of short-run costs. These are: 

1. Short-run total cost (SRTC)
2. Short-run Average Cost (SRAC)
3. Short-run Marginal Cost (SRMC)

Short-run total cost: Total cost is an organisation’s cost when it produces a certain output level. The SRTC has two key elements:

• Total Fixed Cost (TFC): Costs that do not change when output changes. Even if the output is zero, TFC remains constant.
• Total Variable Cost (TVC): Costs directly proportional to a company’s output. Thus, when output increases, TVC increases, and when output decreases, TVC decreases.

SRTC is obtained by adding TFC and TVC. Changes in SRTC are entirely due to changes in TVC. 

Short-run Average Cost: Average cost is obtained by dividing the total cost by the number of units produced. The SRAC is, thus, the per-unit cost of output at the varying production levels. SRAC is obtained by dividing SRTC by output. 

Short-run Marginal Cost: Marginal cost is when the change in a firm’s total costs is divided by changes in the total output. Thus, SRMC exists when there is a change in SRTC due to a change in the company’s output. 

Short-run cost example

X Company wishes to increase its output in the short term. It will need to purchase more raw materials and hire more employees to achieve this. However, its plant capacity or size will be fixed and cannot change. This is because it’s a fixed factor, not a variable.

Sometime later, demand for X Company’s products fell. X Company will look to reduce their output and work hours of employees. The plant cannot be downsized. 

The key takeaway from the above short-run example is that fixed factors cannot be changed in the short-run, even if they may benefit the business. Only variable factors can be changed to aid the business. 

What are long-run costs?

Long-run costs refer to a period where all costs and factors of production are variable and can be changed. These costs are incurred when production levels change over time – a natural course. 

Long-run costs do not encounter the same issue as short-run costs. Whereas the short-run only permits changes to production levels to influence prices, the long-run allows companies to adjust all costs freely. The company also needs to prepare for competition in the long run. In the short run, monopolies are possible.  

Production factors are altered to obtain a higher output level than it currently is. This not only includes hiring more employees (like short-runs) but also plant size expansion or the development of a brand-new plant. The company can also enter or exit according to its expected profits. 

Long-run cost example

X Company has decided to expand its organisation to increase its output. They decide to construct a new plant and expand on their pre-existing one. They have also hired new employees to work. 

When demand drops for their products, the new plant is shut down. The old one only runs at 50% of its full capacity. The output they’re producing is drastically reduced. 

This long-run example shows that all variables can be changed in the long run. Furthermore, some of the changes made overlap with changes that are also possible in the short run. It can be inferred that a long-run cost curve, when plotted, will be assimilated with the help of many short-run cost curves. 

Types of long-run costs 

Long-run costs are also of three types: 

• Long-Run Total Cost (LRTC)
• Long-Run Average Cost (LRAC)
• Long Run Marginal Cost (LRMC)

Long-Run Total Cost: This is the total cost an organisation incurs for producing a specific level of amount. All production factors are variable here. 

Long-Run Average Cost: LRAC is a company’s per-unit cost when producing at a particular output level and when all inputs are variable. This is obtained by plotting individual SRAC curves. 

Long Run Marginal Cost: A company’s incremental cost for producing at a particular output level. Here, none of the input is constant. 

Conclusion

Both short-run and long-run costs are important costs incurred by a business. While long-run costs allow you to change inputs that cannot be changed in the short run, sometimes, a business should keep operating with short-run costs. The superior cost will differ depending on their expected profits, the nature of the market, the business itself, etc.