Fixed and Variable Costs in the Short Run

Core Idea

In the short run, some inputs (capital, premises) are fixed, while others (labor, materials) are variable. Total Cost = Fixed Cost + Variable Cost. Fixed costs don't change with output; variable costs rise as production increases. This distinction explains why firms face different cost structures in the short run (constrained) versus long run (flexible).

How It's Best Learned

Examine a firm's budget: rent is fixed, wages and materials are variable. See how total cost = fixed cost (unchanged) + variable cost (rising with output).

Explainer

From your study of short-run costs, you know that the short run is defined not by calendar time but by the presence of at least one fixed input — an input whose quantity cannot be adjusted regardless of how much the firm produces. The cost of those fixed inputs is the fixed cost (FC): rent on a factory, interest payments on equipment loans, the salary of a permanently contracted manager. These costs do not move whether the firm produces zero units or ten thousand. They are sunk in the short run.

Variable costs (VC), by contrast, move directly with output. If a bakery makes more loaves, it needs more flour, more electricity, more hours from part-time staff. These inputs can be adjusted quickly. Total cost is simply their sum: TC = FC + VC. The graphical implication is stark — on a TC curve plotted against output, the TC curve starts at FC (where VC = 0) and rises as output increases, while the FC curve is a horizontal line at that same height throughout.

The distinction matters most when a firm is deciding whether to keep operating in the short run. Since fixed costs cannot be avoided by shutting down — they are owed regardless — they are irrelevant to the production decision. The relevant comparison is whether revenue covers variable costs. A firm should continue operating as long as price exceeds average variable cost (AVC), even if it is making a loss overall, because operating at least recovers some of the fixed cost. If it shuts down, it still owes the full fixed cost. This is the shutdown condition, and it rests entirely on the FC/VC distinction.

In the long run, the distinction collapses: all inputs become variable, all costs become variable. A firm can exit an industry, renegotiate leases, sell equipment, or redesign its entire production process. The short-run constraint — being locked into a fixed cost — is precisely what creates the asymmetry in behavior between short-run and long-run supply curves and explains why industries adjust sluggishly to demand shocks. The cost structure you inherit in the short run shapes every output, shutdown, and pricing decision until those fixed commitments expire.