Why can the distinction between fixed costs and variable costs be made in the short run?

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Why can the distinction between fixed costs and variable costs be made in the short run?


Why can the distinction between fixed costs and variable costs be made in the short run? Classify the following as fixed or variable costs: advertising expenditures, fuel, interest on companyissued bonds, shipping charges, payments for raw materials, real estate taxes, executive salaries, insurance premiums, wage payments, sales taxes, and rental payments on leased office machinery. “There are no fixed costs in the long run; all costs are variable.” Explain.

Answer and explanationsSolution by a verified expert

The short-run is the economic time span in which there is no enough time available to the producers to change the plant size. The cost associated with the land and machinery is generally considered the fixed cost in the short run, because one cannot change them very quickly once they are installed. The cost that changes with change in output over the short run is generally known as the variable costs such as wage expenses and advertisement expenses. The categorization of the given underlined costs is given in the table based on the based cost theory. In the short run, the output can be increased by increasing the variable factors only.

The advertising and fuel expenses, shipping charges, and payments made for raw materials are all variable costs, as the firm can change them in the short-run period. Also, the wages paid and the sales tax can be declined in the short run by reducing the labor employed and output produced, which makes them variable costs. On the other hand, taxes paid on the real estate, salaries made, interests and premiums paid, depreciation, and rents on machinery are all fixed costs, as they cannot be changed in the short run even when the firm changes its output structure.

In the long run, the firm has enough time to change all the fixed as well as variable expenses. The firm can adjust a land requirement, install a new production unit, and change respective executives in the long run. Firms are more likely to change their plant size in the long run, because they plan their production according to the output projection in the future. Increment or decrement in the plant size, in the long run, leads to making all associated costs variable.

Verified Answer
The distinction is possible when some costs do not change with the change in the output over the short-run period. The costs that change in the short run would be the variable costs and the costs that remain constant would be the fixed costs. Various costs listed are categorized as either fixed or variable in the table below:

Underlying cost Type of cost
Advertising cost Variable cost
Fuel Variable cost
Interest on the bonds issued Fixed cost
Shipping charge Variable cost
Payment of raw materials Variable cost
Real state tax Fixed cost
Executive salaries Fixed cost
Insurance premium Fixed cost
Wage payment Variable cost
Depreciation and obsolescence charges Fixed cost
Sales tax Variable cost
Rental payment on leased office machinery Fixed cost
In the long run, there is enough time available for the firm to alter all the factors employed in the production process. The long-run period is long enough that allows the firm to change its plant size too. As all the factors would be variable in the long run, there exist no fixed costs for such a period.

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