Long-run costs and economies of scale

Key Questions

  • Answer:

    Most economists would probably restate these as fixed costs, which have a longer time horizon than most variable costs; typical examples would be land and buildings.


    Production costs can be considered fixed or variable, and this often depends on the time horizon. When planning a firm before the start of production, all costs are variable, because the firm has not established operations.

    Once in business, of course, things like buildings and equipment often have very long useful life spans and would constitute fixed costs. Variable costs include things like the supplies or materials used directly in producing each unit. For example, in a bakery, flour is a variable cost. The ovens and building are fixed costs -- although firms may convert some items like these to variable costs by renting or leasing them. They are nevertheless fixed for the term of the lease or rental agreement.

    Labor is often problematic because classification of labor very much depends on time horizon. If a firm has little ability to terminate labor in the short-run (as a result of contractual agreements or sometimes by custom), it might be valid to classify these costs as fixed. However, most analyses consider labor to be a variable cost, because in the short run, a firm can increase its quantity of labor by paying overtime or hiring additional workers, much more quickly than it can reconfigure its factories, etc.