Cost-output Relationship
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Cost-output relationship has 2 aspects:
 Cost-output relationship in the short run,
 Cost-output relationship in the long run
 The SR is a period which doesn’t permit
alterations in the fixed equipment (machinery ,
building etc) & in the size of the org.
 The LR is a period in which there is sufficient time
to alter the equipment (machinery, building, land
etc.) & the size of the org. output can be increased
without any limits being placed by the fixed factors
of production
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Cost-output Relationship In The Short
Run
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Short Run may be studied in terms of
 Average Fixed Cost
 Average Variable Cost
 Average Total cost
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 Total, average &
marginal cost
 Fixed cost & variable
cost
1. Total cost (TC) = TFC + TVC,
rise as output rises
1.Total fixed cost (TFC) =
cost of using fixed factors
= cost that does not
change when output is
changed, e.g.
2. Average cost (AC) =
TC/output
3. Marginal cost (MC) = change 2. Total variable cost (TVC) =
cost of using variable
in TC as a result
factors = cost that
of changing output by one
changes when output is
unit
changed,
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Average Fixed Cost and Output
 The greater the output, the lower the fixed
cost per unit, i.e. the average fixed cost.
 Total fixed costs remain the same & do not
change with a change in output.
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Average Variable Cost and output
 The avg. variable costs will first fall & then rise as more &
more units are produced in a given plant.
 Variable factors tend to produce somewhat more
efficiently near a firm’s optimum output than at very low
levels of output.
 Greater output can be obtained but at much greater avg
variable cost.
 E.g. if more & more workers are appointed, it may
ultimately lead to overcrowding & bad org. moreover,
workers may have to be paid higher wages for overtime
work.
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Average Total cost and output
 Average total cost, also known as average costs,
would decline first & then rise upwards.
 Average cost consists of average fixed cost plus
average variable cost.
 Average fixed cost continues to fall with an
increase in output while avg. variable cost first
declines & then rises.
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 So , as Avg. variable cost declines the Avg.
total cost will also decline. But after a point
the Avg. variable cost will rise.
 When the rise in AVC is more than the drop in
Avg. fixed cost that the Avg. total cost will
show a rise.
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Cost-output Relationship In The
Long-Run
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 long run period enables the producers to change
all the factor & he will be able to meet the
demand by adjusting supply. Change in Fixed
factors like building, machinery, managerial staff
etc..
 All factors become variable in the long run.
 In the long run we have only 3 costs i.e. total
cost, Average cost & Marginal Cost
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1. Total cost (TC) = TFC + TVC, rise as output rises
2. Average cost (AC) = TC/output
3. Marginal cost (MC) = change in TC as a result
of changing output by one unit
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 When all the short run situations are combined, it
forms the long run industry.
 During the SR, Demand is less & the plant’s
capacity is limited. When demand rises, the
capacity of the plant is expanded.
 When SR avg. cost curves of all such situations are
depicted, we can derive a long run cost curve out
of that.
 We can make a LR cost curve by joining the
tangency points of all SR curves
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 We use long run costs to decide scale issues, for example
mergers.
 In the long run, we can build any size factory we wish,
based on anticipated demand, profits, and other
considerations.
 Once the plant is built, we move to the short run.
Therefore, it is important to forecast the anticipated
demand. Too small a factory and marginal costs will be
high as the factory is stretched to over produce.
 Conversely too large a factory results in large fixed costs
(e.g.. air conditioning, or taxes) and low profitability.
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Thank You
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