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long-run cost curves

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Short vs Long run

Short run

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In the Short Run

In the short run, firms can only influence prices by changing how much they produce. They have some fixed costs they can't change right away.

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Maximising Profits in the Short Run

When thinking about the short run, firms try to maximise their profits with their given fixed costs and inputs. But this approach isn't sustainable over a long period.

Long run

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In the Long Run

In the long run, all inputs are variable, and there are no fixed costs. Over time, many producers can enter or leave the market, especially during times of profitability or loss.

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Finding the Optimal Mix in the Long Run

In the long run, firms seek to find the best combination of all their inputs that maximises their output and profits.

The main difference between long-run and short-run costs is that in the long run, there are no fixed factors, so there are no fixed costs. All costs are variable. This means that in the long run, the total cost is the same as the total variable cost!

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Example: IBM's Evolution

IBM, the computer software company, started by making things like time-keeping equipment, weighing scales, and coffee grinders.

Over time, they moved to creating punch card systems, then typewriters, mainframes, computers, and now they focus on cloud-based information services.
IBM's decisions and changes over time were based on maximising profits by considering the revenue from each product and the associated costs.
The IBM of today is a result of continually finding the best mix of inputs to maximise profits.

Understanding the long-run

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There are 3 types of long-run cost curves:

Long-run Average Cost (LRAC)

The Long-Run Average Cost (LRAC) curve shows the lowest cost per unit for a firm at each level of output when all production factors can be changed.
This is the per-unit cost of producing different levels of output when all inputs can be varied.
It assumes the firm has chosen the best combination of resources for any amount of production. So, the costs shown on the LRAC curve are the lowest possible costs for each level of output. It's like combining various short-run average cost (SRAC) curves to show the lowest average cost for any output level in the long run.

2. Long-Run Total Cost (LRTC)

This shows the total cost of production for different output levels when all inputs are variable in the long run.
The total cost curve shows the cost associated with every possible level of output. It tells us how much it costs to produce different amounts of goods.

3. Long-Run Marginal Cost (LRMC)

This represents the extra cost of producing one more unit in the long run. It's calculated by dividing the Long-Run Total Cost (LRTC) by the quantity of output produced.

Understanding long-run costs curve

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To find the long-run cost curve, a firm needs to solve their cost-minimisation problem. This means figuring out the cost-effective way to produce a given amount of output.

🧮 Cost-Minimising Choice

By calculating the most cost-effective choice of inputs for every level of output, we can find the cost of producing each level of output. This helps firms produce goods in the cheapest way possible.

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Example: Short-Run vs. Long-Run Costs in a Restaurant

Consider a restaurant that sells hot dogs:

🕰️ Short run

In the short-run, your fixed costs will likely include any interests on any loans, property taxes, insurance etc – these are the costs that do not change depending on what your do in your restaurant.
Your variable costs will include the electricity you use, the food used to make your hot dogs and the costs of the labour you hire.
If you were to increase the number of hours your restaurant was open, then your decision would involve calculating the extra variable costs incurred against the increase in revenue this would generate.
You would not account for a portion of the fixed costs.

⏳ long run

In the long-run however, you must account for both your fixed costs and variable costs to calculate whether you will profitable over time.
For example, if producing each hot dog costs £1 (accounting for the ingredients and labour) and you sell them for £2 each.
If you were to sell 900 hot dogs, then you would generate revenue of £1800, of which £900 would be profit (total revenue minus cost of production).
However, say your rent was £1000 per month, a fixed cost, then the profit generated from producing your hot dogs (£900) would be less than your total costs, hence, this is not a profitable decision.

Therefore, in the short run, this decision would be profitable, but it would not be in the long-run. 🌭

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Note: in the long run, there are no fixed costs in the traditional sense; all costs can be adjusted or varied based on business decisions and market conditions. This means the restaurant can adjust or change its fixed costs, like finding cheaper rent or moving to a larger location.