Solution:

Short-run cost:

• Short-run is a period where the time is too short to expand the size of the industry and the increased demand has to be met within the existing size of industry because certain factors cannot be changed in short run.

• So short-run costs are those which vary with the output when fixed plant a capital equipment remains unchanged.

Cost output relationship in the short-run:

• A change in output is possible only by making changes in the variable inputs like raw materials, labor, etc.

• Inputs like land and buildings, plant and machinery, etc. are fixed in the short-run.

• It means that the short-run is a period not sufficient enough to expand the number of fixed inputs.

• Thus Total Cost (TC) in the The short-run is composed of two elements – Total Fixed Cost (TFC) and Total Variable Cost (TVC).

• TFC remains the same throughout the period and is not influenced by the level of activity.

• The firm will continue to incur these costs even if the firm is temporarily shut down.

• Even though TFC remains the same fixed cost per unit varies with changes in the level of output.

• On the other hand, TVC increases with an increase in the level of activity and decreases with a decrease in the level of activity.

• If the the firm is shut down, there are no variable costs. Even though TVC is variable, the variable cost per unit is constant.

• So in the short-run, an increase in TC implies an increase in TVC only. Thus:

• TC = TFC + TVC

• TFC = TC – TVC

• TVC = TC – TFC

• TC = TFC when the output is zero.

• The graph below shows the Short-run cost output relationship.

  

• In the graph X-axis measures output and the Y-axis measures cost. TFC is a straight line parallel to X-axis because TFC does not change with an increase in output.

• TVC curve is upward rising from the origin because TVC is zero when there is no production and increases as production increases.

• The shape of the TVC curve depends upon the productivity of the variable factors. The TVC curve above assumes the Law of Variable Proportions, which operate in the short run.

• TC curve is also upward rising not from the original but the TFC line. This is because even if there is no production the TC is equal to TFC.

• It should be noted that the vertical distance between the TVC curve and TC curve is constant throughout because the distance represents the amount of fixed cost which remains constant.

• Hence TC curve has the same pattern of behavior as the TVC curve.