Economics Short Run Vs Long Run Costs Questions Medium
Average total cost (ATC) is a measure of the average cost per unit of output produced by a firm. It is calculated by dividing the total cost (TC) by the quantity of output (Q). ATC represents the cost incurred by a firm to produce each unit of output on average.
In the short run, a firm's costs are divided into two categories: fixed costs (FC) and variable costs (VC). Fixed costs are those that do not change with the level of output, such as rent or insurance. Variable costs, on the other hand, vary with the level of output, such as labor or raw materials. In the short run, a firm can only adjust its variable costs to respond to changes in output.
As a result, in the short run, average total cost is influenced by both fixed and variable costs. Initially, as output increases, average total cost tends to decrease due to economies of scale. This is because fixed costs are spread over a larger quantity of output, leading to a lower average cost per unit. However, at a certain point, average total cost starts to increase due to diminishing returns to variable inputs. This is known as the U-shaped average total cost curve in the short run.
In the long run, all costs become variable, meaning that a firm can adjust both its fixed and variable costs to respond to changes in output. In the long run, firms have more flexibility to make adjustments to their production processes, such as expanding or contracting their facilities. As a result, the U-shaped average total cost curve in the short run becomes flatter in the long run.
In the long run, firms can achieve economies of scale by increasing their scale of production, leading to lower average total costs. This is because they can spread their fixed costs over a larger quantity of output. Additionally, firms have the opportunity to adopt more efficient production techniques or invest in new technology, further reducing their average total costs.
Overall, the concept of average total cost is closely related to both short-run and long-run costs. In the short run, average total cost is influenced by both fixed and variable costs, resulting in a U-shaped curve. In the long run, firms have more flexibility to adjust their costs, leading to economies of scale and a flatter average total cost curve.