Relationship Between Short Run And Long Run Average Cost Curve

The cost curves of a firm in the short run and in the long run are not same. Their behavior differs according to the element of time. Short run is the run during which a firm can increase its output by changing the variable factors of production. On the other hand, long run is the run suitable for a firm to increase its output by changing both the fixed and variable factors of production. During the long run a firm can increase its output by introducing new machinery, by constructing new buildings and by adopting new techniques in production.

The long run costs are of two types — long run average and long run marginal cost. Long run average cost indicates how average costs change at different levels of output due to the changes introduced in the size of plant and machinery. It also indicates the production behavior of a firm. It includes several short run average cost curves. In fact, it is the combination of these curves. It is known by different names such as Normal cost curve, Planning curve or Envelop curve. It is called as the normal cost curve because it indicates the various ways for producing the output with normal costs. It is described as the planning curve as it enables the firm to plan its production policy. Since it envelops the various short run average cost curves and since it is tangential to them at a Point, it is known as ‘envelop curve’.

The long run average cost is a U shaped curve. At last it decreases due to the influence of increasing returns. Later it remains constant at the optimum level of output due to the influence of constant returns. Thirdly, increases due to the effect of diminishing returns. The firm secures economies of large scale production in the initial stage. The firm’s economies and dis-economies tend to be equal and it gets normal profits during the second stage. During the third stage, it slopes upward. Hence the long run Average cost curve is a ‘U’ shaped curve due to the operation of law of variable proportions.

The long run Marginal cost curve (LRMC) indicates how a firm produces additional units of output. It is the additional cost incurred for producing one more unit of a commodity. It slopes upwards from left to right. It slopes downwards more steeply when LRAC slopes downwards. It rises upwards more steeply when LRAC slopes upwards. It intersects LRAC at lowest point. Here the firm attains equilibrium by producing the optimum size of output.

The relationship between short run and long run cost curves is explained in the following diagram:

 

 

In the diagram, output is shown along OX axis. Costs are shown along OY oxis, SACS1, ; SAC2 and SAC3 are the three short run average cost curves of three different plants and machinery. SAC denotes the short run costs of plant ‘A’. Plant ‘A’ produces OM units with AM of cost where the size of output is minimum. Hence there is a larger scope of expansion of production. Plant ‘B’ produces OM units with a minimum average cost of ‘PM’. Plant ‘C’ produces OM2 units of output with L1M2 of costs at point L1. Here the Marginal cost is higher than the average cost. In the short run as the firms get abnormal profits at AM1 and abnormal losses at L1M2. It is Only at PM the firms get normal profits.

If we connect different short run average cost curves by drawing line, we get the long run Average cost curve. At point ‘P’ the long run marginal cost curve, intersects the long run Average cost. Here the firm produces OM units with PM costs. Here the average cost and marginal cost of the firm remain equal. If the firm exceeds that limit and produces more units, its marginal cost exceeds average cost. This is not profitable for the firm. Hence a firm stops its output at this point. So PM is the optimum level of output.

Differences between short period and long period average costs:

1) Long period average cost denotes the costs of different plants. But short period average cost denotes the costs of only one particular plant. In the long period, the firm can change its plant size.

2) Long period average cost always remains less than the short period average cost.

3) Long period average cost curve do not intersect any short period cost curve. Its only a tangential line to different short period average cost curves.

4) Long period average cost curve shows the equilibrium output to be produced by a firm. It denotes the optimum size of a firm.

5) Long period average cost curve is flatter than the short period cost curve.

6) Long period average cast curve is equal to one, of the short period average cost curves at a lowest point where long period Marginal cost curve  intersects at the point.

7) Long period average cost shows how production in the long -period can be produced with minimum costs. But the short period average cost curves can’t indicate this.