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Long Run Cost Function

  Long Run average Cost Curve

Long Run average Cost Curve

      The long run is a phase of time during which the industry can change all its raw materials. In the short run, some raw materials are predefined and others are diverse to enhance the degree of productivity.

     In the long run, none of the aspects is predefined and all can be diverse to enlarge productivity. The long run production function has thus no predefined aspects and the industry has no set costs in the long run.

     It is conservative to regard the dimension or degree of plant as a typical fixed raw material. The term plant is here denoted as comprising of capital equipment, machinery, land etc.

     In short run, the dimension of the plant is fixed and it cannot be enhanced or decreased. That is to say one cannot change the volume of capital equipment in the short run, if one has to enhance or reduce productivity.

     Alternatively, long run is a phase of time sufficiently long to permit variations in plant that is in capital equipment, machinery, land etc. In order to extend or retrench productivity.

     Therefore, whilst, in the short run the industry is tied with a given plant, in the long run the industry moves from one plant to another, the industry can make a larger plant if it has enhanced it productivity and a smaller plant if it has to decrease its productivity.

      The long run cost of manufacturing is the least feasible cost of manufacturing any specified degree of productivity when all raw materials are variable, comprising of course the dimension of the plant.

       A long run cost curve portrays the functional association among productivity and the long run cost of manufacturing as just defined. Long run average cost is the long run aggregate cost divided by the degree of productivity.

      Long run average cost curve depicts the least feasible average cost for manufacturing several levels of productivity. In order to understand how long the long run average cost curve is derived; assume the three short run plants are set and each of the short run average cost curves as below.

       These short run average cost curves are also called plant curves since in the short run plant is set and every of the short run average cost curve relates to a specified plant.

       In the short run, the industry can be operating on any short run average cost curve, given the dimension of the plant. Presume that only these three are technically feasible dimensions of plant and that no other dimension of the plant or short run constructed.

       Provided the dimension of the plant or short run average cost curve the industry will enhance or reduce can choose between the three feasible dimensions of plant as presented by short run average cost curves SAC1, SAC2 and SAC3.

       In the long run the industry will scrutinise with which dimension of plant or on which short run SAC2 curve it should operate to manufacture a specified degree of productivity at the minimum feasible cost.

Estimation of Long Run Cost Functions with Engineering

  1. When necessary cross sectional cost-productivity data of industry is not accessible, long run cost function is approximated by either engineering technique or survival technique.
  1. Engineering technique is based on the costs incorporating the physical association among inputs used and productivity manufactured.
  1. In other words, the engineering technique uses knowledge of manufacturing function expressing physical association among raw materials used and productivity produced and from it ascertains the maximum raw material combinations necessary to manufacture several levels of productivity.
  1. The maximum volume of raw materials to manufacture diverse levels of productivity so procured is multiplied by prices of raw materials to procure long run costs of various productivity levels.
  1. The engineering technique is highly useful in estimating long run cost functions when historical cost productivity data of industries, particularly, of new improved products are not obtainable.
  1. A merit of the engineering technique over cross-sectional regression study is that it depends on the recent technology and in this way it is able to ignore the complexities faced in cross sectional study which occur out of several industries using varied technologies, new and ancient.
  1. Moreover the complexity associating to the identification of costs occurred on manufacturing diverse products and valuation of raw materials used for manufacturing which arise in cross sectional regression analysis also does not happen in this engineering method.
  1. Nevertheless, the engineering technique for estimating cost function is also without difficulty. First the engineering way depends on the physical production function and input prices and does not take into account administrative, marketing and functioning costs.
  1. Also, the engineering mode is concerned with maximum rather than real world cost productivity association. The engineering technique has been successfully used to approximate long productivity association.
  1. The approximates of long run cost function found by the use of engineering technique also corroborate the outcome of cross-sectional regression analysis that there is primarily economies of scale but beyond a point invariable returns to scale happens that is long run cost curve is L shaped.

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