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
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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 &  Fixed cost & variable
marginal cost cost

1. Total cost (TC) = TFC + TVC, 1.Total fixed cost (TFC) =

rise as output rises
2. Average cost (AC) =
TC/output
cost of using fixed factors
= cost that does not
change when output is
changed, e.g.

2. Total variable cost (TVC) =

3. Marginal cost (MC) = change
in TC as a result
of changing output by one
unit
cost of using variable
factors = cost that
changes when output is
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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