Production and Cost Analysis in the Short-Run and Long-Run
An Increase In Wages
Total cost is the summation of variable cost and fixed cost. The average cost is per unit cost of production and is mathematically derived by dividing total cost by the total unit of production (Salop & Scheffman, 1987). Marginal cost is the incremental cost incurred due to a unit increase in production. In the short run, fixed costs are the costs, which are incurred by the firm and are normally fixed like the rent of the land or the overhead of the firm. Variable costs are the costs incurred fro per unit production. Variable costs include the cost of labor, fuel, raw material, etc. Labor is a function of the cost of labor, wherein labor cost is the product of total labor hours and wage per hour. As there is an increase in the wage, the cost of labor will increase. This will increase variable cost, and therefore the average variable cost will increase. Further, marginal cost being the incremental cost due to increase unit increase in production will also increase as there is an increase in labor cost due to an increase in wage.
In the long run, there is no fixed cost and all costs are assumed to vary; therefore, an increase in wage will increase cost in the long run. Therefore, due to an increase in the wage, the overall cost will increase, shifting the marginal cost curve to the right and the average variable cost curve upward.
A Decrease In Material Costs
A decrease in material cost will reduce variable cost in the short run, as it will reduce the cost per unit of production (Hicks, 1935). Consequently, the average variable cost declines in the short run, and the average variable curve shifts downward due to a decrease in the average variable cost. The marginal cost will also decline. This is so because, in the short run, marginal cost is actually the change in cost due to a change in variable cost, and therefore the marginal cost curve will shift downward.
In the long run, all the cost components vary. Therefore, a decline in material cost will decrease the overall cost of production, and therefore, the average cost will also decrease. This will be demonstrated by a slight downward shift in the long-run average cost curve.
The Government Imposes a Fixed Amount of Tax
When a fixed amount of tax is imposed in the short run, it becomes a part of the fixed cost of the company (Baumol, 1972). Therefore, it will not affect the variable cost of the firm. Further, the marginal cost is not affected as the tax remains fixed even for one extra unit of production. Therefore, an imposition of a fixed tax will not affect the marginal cost curve or the average variable cost.
In the long run, variability of the costs is assumed (Salop & Scheffman, 1987). Therefore, it will also be assumed that the tax will vary with time. Therefore, the average cost, as well as the marginal cost, will be affected due to a change in cost as tax is imposed.
The Rent That The Firm Pays On The Building That It Leases Decreases
Rent paid on the land that the farm leases is a fixed cost in the short run. Therefore, when this cost declines in the short run, variable cost is not affected, nor is marginal cost (Stigler, 1939). However, in the long run, with a decline in the cost of rent, total cost in the long run declines, and so the average cost and the marginal cost will fall. This will cause both the curves to move down and tot he left respectively.
Baumol, W. (1972). On Taxation and the Control of Externalities. The American Economic Review Vol. 63 No. 3 , 307-322.
Hicks, J. (1935). Annual Survey of Economic Theory: the Theory of Monopoly. Econometrica Vol. 3 No. 1 , 1-20.
Salop, S. C., & Scheffman, D. T. (1987). Cost-Raising Strategies. The Journal of Industrial Economics Vol. 36 No. 1 , 19-34.
Stigler, G. (1939). Production and Distribution in the Short Run. The Journal of Political Economy Vol. 47 No. 3 , 305-327.