A fundamental principle that guides the cost behavior of an organization is that there exists a direct relationship between cost and output. Although variables other than output, such as the price of factors of production, the structure of an organization, and the latter's ability to efficiently utilize the input resources may have a bearing on cost, they are usually held constant in most cost analysis, especially in the short run. In the long run, all costs and related factors of production are variable. Since organizations at different levels of production operate differently, it is difficult to determine a priori the time period for short run. However, the time period for long run can be determined by the relationship between inputs and the production process. In general, the more capital intensive an operation, i.e., the more capital an organization uses in relation to labor, the longer it takes for the production process to change.
This chapter discusses three basic elements of cost behvior that are important to understanding the nature of costs and how they affect the functioning of an organization: time frame of costs, general properties of cost functions, and cost estimation. Of these, cost estimation is particularly important for determining the nature of current as well as future costs of an organization.
Although it may be difficult to determine the exact time period that separates a short-run from a long-run cost, the concepts nevertheless have important implications for decision making in an organization. For instance, the short-run is an operating concept. As an operating concept, it deals with the day-to-day operations of an organization. Thus, when an organization wants to deal with its routine activities (such as collecting garbage, supplying water, or fixing traffic lights), it relies on its short-run cost functions. On the other hand, the long run, which includes many short runs, is a planning concept and, as a planning concept, it deals with non-routine activities of an