Nature of Costs in the Long Run

In the short run, costs can be classified into fixed or variable categories. Variable costs fluctuate with the level of production or service activity, and these could include the salaries of hourly workers and raw material costs. The quantity of these inputs must increase to supply a greater quantity of services, making them the source of short-run variable costs.

In contrast, fixed costs are those that do not change with the level of output. For example, the contractual commitments related to a long-term lease of its factory and heavy production equipment may not be alterable. This lack of flexibility to make adjustments causes firms to consider these costs as being fixed in the short run. They do not change with the firm's output.

However, if the firm anticipates growth in the long run, it can purchase a larger factory space or buy more heavy machinery once its commitments from these existing leases expire. This flexibility over factory size and quantity of heavy machinery then creates costs that will increase with the higher anticipated output. This illustrates how the sources of costs that were once considered fixed in the short run become then considered variable in the long run.

It further illustrates that the difference in short-run versus long-run time periods is not a set calendar interval of time. The difference is the time needed for the firm to exercise complete flexibility in determining the quantity of inputs that defines the difference in short-run versus long-run cost considerations.

Many items used by a firm can be obtained from the capital rental markets. A firm can rent items such as machinery, equipment, software, and commercial spaces in these markets instead of purchasing them outright. It also allows the firm to access the latest technologies or facilities without committing large sums of money.