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Home Cost Analysis Analysis of Short Run Cost of Production

Analysis of Short Run Cost of Production:

 

Definition of Short Run:

 

Short run is a period of time over which at least one factor must remain fixed. For most of the firms, the fixed resource or factors which cannot be increased to meet the rising demand of the good is capital i.e., plant and machinery.

 

Short run, then, is a period of time over which output can be changed by adjusting the quantities of resources such as labor, raw material, fuel but the size or scale of the firm remains fixed.

 

Definition of Long Run:

 

In the long run there is no fixed resource. All the factors of production are variable. The length of the long run differs from industry to industry depending upon the nature of production.

 

For example, a balloon making firm can change the size of firm more quickly than a car manufacturing firm.

 

Categories/Types of Costs in the Short Run:

 

The total cost of a firm in the short run is divided into two categories (1) Fixed cost and (2) Variable cost. The two types of economic costs are now discussed in brief.

      

(1) Total Fixed Cost (TFC):

 

Total fixed cost occur only in the short run. Total Fixed cost as the name implies is the cost of the firm's fixed resources, Fixed cost remains the same in the short run regardless of how many units of output are produced. We can say that fixed cost of a firm is that part of total cost which does not vary with changes in output per period of time. Fixed cost is to be incurred even if the output of the firm is zero.

 

For example, the firm's resources which remain fixed in the short run are building, machinery and even staff employed on contract for work over a particular period.

 

(2) Total Variable Cost (TVC): 

  

Total variable cost as the name signifies is the cost of variable resources of a firm that are used along with the firm's existing fixed resources. Total variable cost is linked with the level of output. When output is zero, variable cost is zero. When output increases, variable cost also increases and it decreases with the decrease in output. So any resource which can be varied to increase or decrease with the rate of output is variable cost of the firm.

 

For example, wages paid to the labor engaged in production, prices of raw material which a firm. incurs on the production of output are variable costs. A firm can reduce its variable cost by lowering output but it cannot decrease its fixed cost. These expenses remain fixed in the short run. In the long run there are no fixed resources. All resources are variable. Therefore, a firm has no fixed cost in the long run. All long run costs are variable costs.

 

(3) Total Cost (TC):

           

Total cost is the sum of fixed cost and variable cost incurred at each level of output. Total cost of production of a firm equals its fixed cost plus its:

 

Formula:

 

TC = TFC + TVC

 

Where:

 

TC = Total cost.

 

TFC = Total fixed cost.

 

TVC = Total variable cost.

 

Explanation:

 

Short run costs of a firm is now explained with the help of a schedule and diagrams. 

 

Schedule:

 

(in Dollars)

Units of Output (in Hundred)

Total Fixed Cost

Total Variable Cost

Total Cost

0

1000

0

1000

1

1000

60

1060

2

1000

100

1100

3

1000

150

1150

4

1000

200

1200

5

1000

400

1400

6

1000

700

1700

7

1000

1100

2100

 

The short run cost data of the firm shows that total fixed cost TFC (column 2) remains constant at $1000/- regardless of the level of output.

 

The column 3 indicates variable cost which is associated with the level of output. Total variable cost is zero when production is zero. Total variable cost increases with the increase in output. The variable does not increase by the same amount for each increase in output. Initially the variable cost increases by a smaller amount up to 3rd unit of output and after which it increases by larger amounts.

 

Column (4) indicates total cost which is the sum of TFC + TVC. The total cost increases for each level of output. The rise in total cost is more sharp after the 4th level of output. The concepts of costs, i.e., (1) total fixed cost (2) total variable cost and (3) total cost can be illustrated graphically.

 

(i) Total Fixed Cost Curve/Diagram:

 

 

In this diagram (13.1) the total fixed cost of a firm is assumed to be $1000 at various levels of output. It remains the same even if the firm's output is zero.

 

(ii) Total Variable Cost Curve/Diagram:

 

 

In the figure (13.2), the total variable cost curve (TVC) increases with the higher level of output. It starts from the origin. Then increases at a diminishing rate up to the 4th units of output. It then begins to rise at an increasing rate.

 

Total Cost Curve Curve/Diagram:

 

 

In the figure (13.3), total cost curve which is the sum of the total fixed cost and variable cost at various levels of output has nearly the same shape. The difference between the two is by only a fixed amount of $1,000. The total variable cost curve and the total cost curve begin to rise more rapidly as production is increased. The reason for this is that after a certain

output, the business has passed its most efficient use of its fixed costs machinery, building etc., and its diminishing return begins to set in.

 

Analytical Importance of Fixed and Variable Costs:

        

In the time of distinction between fixed cost and variable cost is a matter of degree, it all depends upon the contracts of a firm and .the period of time under consideration.

 

For example, if a firm makes contract with the labor for a certain period, then the firm has to bear the cost of the labor irrespective of the total produce. Under such conditions, the wages paid to the labor will be classified as fixed cost and not variable cost, as discussed under the heading of variable cost. Secondly, when the period of time is short, the distinction between fixed cost and variable cost can be made rigid but not in a longer period of time all fixed costs change into variable cost in the long run.

Relevant Articles:

Concept of Cost of Production
Concepts of Economic Costs

Analysis of Short Run Cost of Production

Average Cost
Short Run and Long Run Average Cost Curves
Marginal Cost
Relation of Average Variable Cost and Average Total Cost to Marginal Cost
 

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
Theory of Factor Pricing OR Theory of Distribution
Rent
Wages
Interest
Profits
Principles and Theories of Macro Economics
National Income and Its Measurement
Principles of Public Finance
Public Revenue and Taxation
National Debt and Income Determination
Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance
History of Money

 

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