What are the differences between short run and long run costs?
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Last updated 4 Sept 2023
Short-run and long-run costs are concepts used in economics to analyze and understand how costs vary over different time horizons in the production of goods and services. These concepts are particularly important in the context of microeconomics and the theory of the firm
- Short-run costs: The short run refers to a period of time during which at least one factors of production are fixed or cannot be changed. In the short run, a firm can adjust its production level by varying the variable factors, such as labour and raw materials. However, it cannot change its fixed factors, such as plant and equipment.
- Long-run costs: The long run, on the other hand, is a period of time in which all factors of production are variable, meaning a firm can adjust both its variable factors and its fixed factors. In the long run, firms have more flexibility to adapt to changing conditions and can make adjustments to their production processes, including expanding or reducing their capacity. This allows them - in theory - to achieve increasing returns to scale, otherwise known as economies of scale
Variable and Fixed Costs:
- Short-run costs: In the short run, costs are divided into two categories: variable costs and fixed costs. Variable costs change with the level of production. For example, as a firm produces more units, it incurs higher variable costs, such as labour and raw materials. Fixed costs remain constant in the short run because the firm cannot change its fixed inputs. Examples of fixed costs include rent on a factory and the depreciation of machinery.
- Long-run costs: In the long run, all costs are variable because a firm can adjust its production capacity and all inputs can be modified. This means that both variable costs and fixed costs can change in response to changes in production levels or the scale of operations.
In the long run, firms have more flexibility to optimise their production processes, and they can achieve internal economies of scale or optimal scale (otherwise known as minimum efficient scale) where average costs are minimised. This is the point at which the LRAC curve reaches its lowest point.