Short-run and Long-run Cost Curves

The short run and long run are defined by flexibility, not a fixed calendar. In the short run, at least one productive input or commitment cannot be changed. In the long run, all productive inputs can be adjusted and firms may enter or leave.

A bakery that already installed a small oven must choose labor around that oven today. Its short-run average-total-cost curve belongs to that plant. When renewing facilities, it can compare small, medium, and large plants.

The long-run envelope

For each target output, the firm chooses the plant with the lowest attainable average cost. Connecting those choices gives the long-run average cost (LRAC) curve. It is an envelope around short-run plant curves:

The firm need not use one plant for every quantity. A small café layout may be cheapest for 100 meals, while a centralized kitchen is cheaper for 2,000.

Short-run fixed cost is avoidable in the long run, but not every historical payment becomes recoverable. Long-run flexibility means future commitments can change; it does not reverse sunk expenditures.

Planning with uncertainty

The lowest expected cost is not always the only consideration. A larger plant may provide capacity insurance but create idle cost if demand remains low. A smaller flexible plant may cost more per unit yet reduce downside risk. Firms compare expected demand, adjustment costs, financing, reliability, and the value of waiting.

Choose a plant at three outputs

Suppose small, medium, and large kitchens have average costs of 8, 11, and 16 at 100 meals; 10, 7, and 10 at 200; and 15, 9, and 6 at 300. If the small kitchen is already installed, its values describe the short-run choices. In long-run planning, choose the minimum in each column: small at 100, medium at 200, and large at 300.

Connecting those minimum points creates the LRAC envelope. It is not the arithmetic average of plant curves and it is not the cost of one giant plant used at every output.

Planning includes uncertainty

A restaurant rarely knows future orders exactly. A large kitchen may be cheapest at 300 meals but expensive when only 100 arrive. Managers compare demand scenarios, financing, delay, reversibility, and the value of spare capacity. The least-cost plant at one forecast is a starting point, not the complete recommendation.

Ask two questions in order: what is fixed for the current decision, and which alternatives become adjustable over the planning horizon?