Different Types of Costs
- In preparing goods/services for sale, firms incur a range of costs. These costs can be be broken into different categories
- Fixed costs (FC) are costs that do not change as the level of output changes
- These have to be paid whether output is zero or 5000
- E.g. Building rent, management salaries, insurance, bank loan repayments, etc.
- E.g. Building rent, management salaries, insurance, bank loan repayments, etc.
- These have to be paid whether output is zero or 5000
- Variable costs (VC) are costs that vary directly with output
- These increase as output increases, & vice versa
- E.g. Raw material costs, wages of workers directly involved in production
- E.g. Raw material costs, wages of workers directly involved in production
- These increase as output increases, & vice versa
- Total costs (TC) are the sum of the fixed + total variable costs
The distinction between short run and long run costs
- The distinction between short run and long run costs revolves around the degree of flexibility in adjusting inputs (the factor of production)
- In the short run, some inputs are fixed and cannot be varied easily, such as capital equipment or the size of the production facility
- Variable inputs like labour and raw materials can to a certain extent be adjusted
- Short run costs include both fixed and variable costs, but the state of capital is fixed
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In the long run, all inputs are able to change
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Firms have the flexibility to adjust their production processes, expand or contract their scale of operations, and invest in new capital equipment
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Consequently, all costs become variable as firms can make adjustments to their input mix to optimise production efficiency
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