Control Process

Ø   By Anil Giri (2910084)
Control (management) Introduction

Controlling is ones of the managerial functions like planning, organizing, staffing and directing. It is an important function because it helps to check the errors and to take the corrective action so that deviation from standards are minimized and stated goals of the organization are achieved in desired manner.

Characteristics of ControlControl is a continuous process

·         Control is a management process

·         Control is embedded in each level of organizational hierarchy

·         Control is forward looking

·         Control is closely linked with planning

·         Control is a tool for achieving organizational activities

·         Control is an end process

Features of Controlling Function

Following are the characteristics of controlling function of management-

1.Controlling is an end function- A function which comes once the performances are made in confirmities with plans.

2.Controlling is a pervasive function- which means it is performed by managers at all levels and in all type of concerns.

3.Controlling is forward looking- because effective control is not possible without past being controlled. Controlling always look to future so that follow-up can be made whenever required.

4.Controlling is a dynamic process- since controlling requires taking reviewal methods, changes have to be made wherever possible.

5.Controlling is related with planning- Planning and Controlling are two inseperable functions of management. Without planning, controlling is a meaningless exercise and without controlling, planning is useless. Planning presupposes controlling and controlling succeeds planning.

Ø  Control Process

The control process involves carefully collecting information about a system, process, person, or group of people in order to make necessary decisions about each. Managers set up control systems that consist of four

1.Establish standards to measure performance. Within an organization's overall strategic plan, managers define goals for organizational departments in specific, operational terms that include standards of performance to compare with organizational activities.

2.Measure actual performance. Most organizations prepare formal reports of performance measurements that managers review regularly. These measurements should be related to the standards set in the first step of the control process. For example, if sales growth is a target, the organization should have a means of gathering and reporting sales data.

3.Compare performance with the standards. This step compares actual activities to performance standards. When managers read computer reports or walk through their plants, they identify whether actual performance meets, exceeds, or falls short of standards. Typically, performance reports simplify such comparison by placing the performance standards for the reporting period alongside the actual performance for the same period and by computing the variance—that is, the difference between each actual amount and the associated standard.

4.Take corrective actions. When performance deviates from standards, managers must determine what changes, if any, are necessary and how to apply them. In the productivity and quality-centered environment, workers and managers are often empowered to evaluate their own work. After the evaluator determines the cause or causes of deviation, he or she can take the fourth step—corrective action. The most effective course may be prescribed by policies or may be best left up to employees' judgment and initiative

Ø  Control Techniques

Control techniques provide managers with the type and amount of information they need to measure and monitor performance. The information from various controls must be tailored to a specific management level, department, unit, or operationTo ensure complete and consistent information, organizations often use standardized documents such as financial, status, and project reports. Each area within an organization, however, uses its own specific control techniques, described in the following sections.

§  Financial controls

After the organization has strategies in place to reach its goals, funds are set aside for the necessary resources and labor. As money is spent, statements are updated to reflect how much was spent, how it was spent, and what it obtained. Managers use these financial statements, such as an income statement or balance sheet, to monitor the progress of programs and plans. Financial statements provide management with information to monitor financial resources and activities. The income statement shows the results of the organization's operations over a period of time, such as revenues, expenses, and profit or loss. The balance sheet shows what the organization is worth (assets) at a single point in time, and the extent to which those assets were financed through debt (liabilities) or owner's investment (equity).

Financial audits, or formal investigations, are regularly conducted to ensure that financial management practices follow generally accepted procedures, policies, laws, and ethical guidelines. Audits may be conducted internally or externally. Financial ratio analysis examines the relationship between specific figures on the financial statements and helps explain the significance of those figures:

•Liquidity ratios measure an organization's ability to generate cash.

•Profitability ratios measure an organization's ability to generate profits.

•Debt ratios measure an organization's ability to pay its debts.

•Activity ratios measure an organization's efficiency in operations and use of assets.

In addition, financial responsibility centers require managers to account for a unit's progress toward financial goals within the scope of their influences. A manager's goals and responsibilities may focus on unit profits, costs, revenues, or investments.

§  Budget controls

A budget depicts how much an organization expects to spend (expenses) and earn (revenues) over a time period. Amounts are categorized according to the type of business activity or account, such as telephone costs or sales of catalogs. Budgets not only help managers plan their finances, but also help them keep track of their overall spending.

A budget, in reality, is both a planning tool and a control mechanism. Budget development processes vary among organizations according to who does the budgeting and how the financial resources are allocated. Some budget development methods are as follows:

•Top-down budgeting. Managers prepare the budget and send it to subordinates.

•Bottom-up budgeting. Figures come from the lower levels and are adjusted and coordinated as they move up the hierarchy.

•Zero-based budgeting. Managers develop each new budget by justifying the projected allocation against its contribution to departmental or organizational goals.

•Flexible budgeting. Any budget exercise can incorporate flexible budgets, which set “meet or beat” standards that can be compared to expenditures.

§  Marketing controls

Marketing controls help monitor progress toward goals for customer satisfaction with products and services, prices, and delivery. The following are examples of controls used to evaluate an organization's marketing functions:

•Market research gathers data to assess customer needs—information critical to an organization's success. Ongoing market research reflects how well an organization is meeting customers' expectations and helps anticipate customer needs. It also helps identify competitors.

•Test marketing is small-scale product marketing to assess customer acceptance. Using surveys and focus groups, test marketing goes beyond identifying general requirements and looks at what (or who) actually influences buying decisions.

•Marketing statistics measure performance by compiling data and analyzing results. In most cases, competency with a computer spreadsheet program is all a manager needs. Managers look at marketing ratios, which measure profitability, activity, and market shares, as well as sales quotas, which measure progress toward sales goals and assist with inventory controls.

Unfortunately, scheduling a regular evaluation of an organization's marketing program is easier to recommend than to execute. Usually, only a crisis, such as increased competition or a sales drop, forces a company to take a closer look at its marketing program. However, more regular evaluations help minimize the number of marketing problems.

§  Human resource controls

Human resource controls help managers regulate the quality of newly hired personnel, as well as monitor current employees' developments and daily performances.

On a daily basis, managers can go a long way in helping to control workers' behaviors in organizations. They can help direct workers' performances toward goals by making sure that goals are clearly set and understood. Managers can also institute policies and procedures to help guide workers' actions. Finally, they can consider past experiences when developing future strategies, objectives, policies, and procedures.

Common control types include performance appraisals, disciplinary programs, observations, and training and development assessments. Because the quality of a firm's personnel, to a large degree, determines the firm's overall effectiveness, controlling this area is very crucial.

§  Computers and information controls

Almost all organizations have confidential and sensitive information that they don't want to become general knowledge. Controlling access to computer databases is the key to this area.

Increasingly, computers are being used to collect and store information for control purposes. Many organizations privately monitor each employee's computer usage to measure employee performance, among other things. Some people question the appropriateness of computer monitoring. Managers must carefully weigh the benefits against the costs—both human and financial—before investing in and implementing computerized control techniques.

Although computers and information systems provide enormous benefits, such as improved productivity and information management, organizations should remember the following limitations of the use of information technology:

·         Performance limitations. Although management information systems have the potential to increase overall performance, replacing long-time organizational employees with information systems technology may result in the loss of expert knowledge that these individuals hold. Additionally, computerized information systems are expensive and difficult to develop. After the system has been purchased, coordinating it—possibly with existing equipment—may be more difficult than expected. Consequently, a company may cut corners or install the system carelessly to the detriment of the system's performance and utility. And like other sophisticated electronic equipment, information systems do not work all the time, resulting in costly downtime.

·         Behavioral limitations. Information technology allows managers to access more information than ever before. But too much information can overwhelm employees, cause stress, and even slow decision making. Thus, managing the quality and amount of information available to avoid information overload is important.

Cost Concepts

 by Anchal (2910072)

Cost Definition:-Introduction

An amount that has to be paid or given up in order to get something.

In business, cost is usually a monetary valuation of (1) effort, (2) material, (3) resources, (4) time and utilities consumed, (5) risks incurred, and (6) opportunity forgone in production and delivery of a good or service.

         All expenses are costs, but not all costs acquisition of an income- are expenses.

1.Cost Function:-

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salary of an IT professional leaving the organization.”3 In addition, this rule of thumb understates the cost of lost productivity when many employees in any given functional area must be replaced over a short period.

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2.Concept of Cost :-

Cost accounting is concerned with cost and therefore is necessary to understand the meaning of term cost in a proper perspective. In general, cost means the amount of expenditure (actual or notional) incurred on, or attributable to a given thing.

However, the term cost cannot be exactly defined. Its interpretation depends upon the following factors:

• The nature of business or industry
• The context in which it is used

In a business where selling and distribution expenses are quite nominal the cost of an article may be calculated without considering the selling and distribution overheads. At the same time, in a business where the nature of a product requires heavy selling and distribution expenses, the calculation of cost without taking into account the selling and distribution expenses may prove very costly to a business. The cost may be factory cost, office cost, cost of sales and even an item of expense.

       For example, prime cost includes expenditure on direct materials, direct labor and direct expenses. Money spent on materials is termed as cost of materials just like money spent on labor is called cost of labor and so on. Thus, the use of term cost without understanding the circumstances can be misleading.

Different costs are found for different purposes. The work-in-progress is valued at factory cost while stock of finished goods is valued at office cost. Numerous other examples can be given to show that the term “cost” does not mean the same thing under all circumstances and for all purposes. Many items of cost of production are handled in an optional manner which may give different costs for the same product or job without going against the accepted principles of cost accounting. Depreciation is one of such items.

Elements of Cost :-

Following are  the three broad elements of cost:

1.Material:-

The substance from which a product is made is known as material. It may be in a raw or a manufactured state. It can be direct as well as indirect.

(a)  Direct Material:

The material which becomes an integral part of a finished product and which can be conveniently assigned to specific physical unit is termed as direct material. Following are some of the examples of direct material:

Ø .All material or components specifically purchased, produced or requisitioned from stores.

Ø  Primary packing material (e.g., carton, wrapping, cardboard, boxes etc.)

Ø  Purchased or partly produced components .

Direct material is also described as process material, prime cost material, production material, stores material, constructional material etc.

(b) Indirect Material:  The material which is used for purposes ancillary to the business and which cannot be conveniently assigned to specific physical units is termed as indirect material. Consumable stores, oil and waste, printing and stationery material etc. are some of the examples of indirect material. Indirect material may be used in the factory, office or the selling and distribution divisions.

2.Labor:- For conversion of materials into finished goods, human effort is needed and such human effort is called labor. Labor can be direct as well as indirect.

(a) Direct Labor: The labor which actively and directly takes part in the production of a particular commodity is called direct labor. Direct labor costs are, therefore, specifically and conveniently traceable to specific products.

Direct labor can also be described as process labor, productive labor, operating labor, etc.

(B) Indirect Labor:

The labor employed for the purpose of carrying out tasks incidental to goods produced or services provided, is indirect labor. Such labor does not alter the construction, composition or condition of the product. It cannot be practically traced to specific units of output. Wages of storekeepers, foremen, timekeepers, directors’ fees, salaries of salesmen etc, are examples of indirect labor costs.

3.Expenses:- Expenses may be direct or indirect.

(a)Direct Expenses:  These are the expenses that can be directly, conveniently and wholly allocated to specific cost centers or cost units. Examples of such expenses are as follows:

Ø  Hire of some special machinery required for a particular contract

Ø  Cost of defective work incurred in connection with a particular job or contract etc.

(c)   Indirect Expenses:- These are the expenses that cannot be directly, conveniently and wholly allocated to cost centers or cost units. Examples of such expenses are rent, lighting, insurance charges etc.

1.      4.Overhead:- The term overhead includes indirect material, indirect labor and indirect expenses. Thus, all indirect costs are overheads.

A manufacturing organization can broadly be divided into the following three divisions:

Ø  Factory or works, where production is done

Ø  Office and administration, where routine as well as policy matters are decided

Ø  Selling and distribution, where products are sold and finally dispatched to customers

Overheads may be incurred in a factory or office or selling and distribution divisions. Thus, overheads may be of three types:

A.Factory Overheads:- They include the following things:

Ø  Indirect material used in a factory such as lubricants, oil, consumable stores etc.

Ø  Indirect labor such as gatekeeper, timekeeper, works manager’s salary etc.

Ø  Indirect expenses such as factory rent, factory insurance, factory lighting etc.

B.Office and Administration Overheads :- They include the following things:

Ø  Indirect materials used in an office such as printing and stationery material, brooms and dusters etc.

Ø  Indirect labor such as salaries payable to office manager, office accountant, clerks, etc.

Ø  Indirect expenses such as rent, insurance, lighting of the office

C.Selling and Distribution Overheads:- They include the following things:

Ø  Indirect materials used such as packing material, printing and stationery material etc.

Ø  Indirect labor such as salaries of salesmen and sales manager etc.

Ø  Indirect expenses such as rent, insurance, advertising expenses etc.

Components of Total Cost :-

1.Prime Cost :- Prime cost consists of costs of direct materials, direct labors and direct expenses. It is also known as basic, first or flat cost.

2.Factory Cost :- Factory cost comprises prime cost and, in addition, works or factory overheads that include costs of indirect materials, indirect labors and indirect expenses incurred in a factory. It is also known as works cost, production or manufacturing cost.

3.Office Cost:-  Office cost is the sum of office and administration overheads and factory cost. This is also termed as administration cost or the total cost of production.

4.Total Cost :- Selling and distribution overheads are added to the total cost of production to get total cost or the cost of sales.

Various components of total cost can be depicted with the help of the table below:

Components of total cost
Direct material Direct labor Direct expenses	Prime cost or direct cost or first cost
Prime cost plus works overheads	Works or factory cost or production cost or manufacturing cost
Works cost plus office and administration overheads	Office cost or total cost of production
Office cost plus selling and distribution overheads	Cost of sales or total cost

Classification of Cost:-  Cost may be classified into different categories depending upon the purpose of classification. Some of the important categories in which the costs are classified are as follows:

1. Fixed, Variable and Semi-Variable Costs :- The cost which varies directly in proportion with every increase or decrease in the volume of output or production is known as variable cost. Some of its examples are as follows:

Ø  Wages of laborers

Ø  Cost of direct material

Ø  Power

The cost which does not vary but remains constant within a given period of time and a range of activity inspite of the fluctuations in production is known as fixed cost. Some of its examples are as follows:

Ø  Rent or rates

Ø  Insurance charges

Ø  Management salary

The cost which does not vary proportionately but simultaneously does not remain stationary at all times is known as semi-variable cost. It can also be named as semi-fixed cost. Some of its examples are as follows:

Ø  Depreciation

Ø  Repairs

Fixed costs are sometimes referred to as “period costs” and variable costs as “direct costs” in system of direct costing. Fixed costs can be further classified into:

Ø  Committed fixed costs

Ø  Discretionary fixed costs

2.      Product Costs and Period Costs:- The costs which are a part of the cost of a product rather than an expense of the period in which they are incurred are called as “product costs.” They are included in inventory values. In financial statements, such costs are treated as assets until the goods they are assigned to are sold. They become an expense at that time. These costs may be fixed as well as variable, e.g., cost of raw materials and direct wages, depreciation on plant and equipment etc. The costs which are not associated with production are called period costs. They are treated as an expense of the period in which they are incurred

3.      Direct and Indirect Costs:- The expenses incurred on material and labor which are economically and easily traceable for a product, service or job are considered as direct costs. In the process of manufacturing of production of articles, materials are purchased, laborers are employed and the wages are paid to them. Certain other expenses are also incurred directly. All of these take an active and direct part in the manufacture of a particular commodity and hence are called direct costs.

4.      Decision-Making Costs and Accounting Costs :-  Decision-making costs are special purpose costs that are applicable only in the situation in which they are compiled. They have no universal application. They need not tie into routine-financial accounts. They do not and should not conform the accounting rules. Accounting costs are compiled primarily from financial statements. 

5.        Relevant and Irrelevant Costs:-  Relevant costs are those which change by managerial decision. Irrelevant costs are those which do not get affected by the decision. For example, if a manufacturer is planning to close down an unprofitable retail sales shop, this will affect the wages payable to the workers of a shop. This is relevant in this connection since they will disappear on closing down of a shop. But prepaid rent of a shop or unrecovered costs of any equipment which will have to be scrapped are irrelevant costs which should be ignored.

6.      Differentials, Incremental or Decrement Cost :-

The difference in total cost between two alternatives is termed as differential cost. In case the choice of an alternative results in an increase in total cost, such increased costs are known as incremental costs. While assessing the profitability of a proposed change, the

incremental costs are matched with incremental revenue. This is explained with the following example:

Example

A company is manufacturing 1,000 units of a product. The present costs and sales data are as follows:

Selling price per unit	$. 10
Variable cost per unit	$. 5
Fixed costs	$. 4,000

7.Production, Administration and Selling and Distribution Costs:-        

A business organization performs a number of functions, e.g., production, illustration, selling and distribution, research and development. Costs are to be curtained for each of these functions. The Chartered Institute of Management accountants, London, has defined each of the above costs as follows:

·         Production Cost :-The cost of sequence of operations which begins with supplying materials, labor and services and ends with the primary packing of the product. Thus, it includes the cost of direct material, direct labor, direct expenses and factory overheads.

·         Administration Cost :-The cost of formulating the policy, directing the organization and controlling the operations of an undertaking which is not related directly to a production, selling, distribution, research or development activity or function.

·         Selling Cost :-It is the cost of selling to create and stimulate demand (sometimes termed as marketing) and of securing orders.

·         Distribution Cost :-It is the cost of sequence of operations beginning with making the packed product available for dispatch and ending with making the reconditioned returned empty package, if any, available for reuse.

·         Research Cost :-It is the cost of searching for new or improved products, new application of materials, or new or improved methods.

·         Development Cost :-The cost of process which begins with the implementation of the decision to produce a new or improved product or employ a new or improved method and ends with the commencement of formal production of that product or by the method.

·         Pre-Production Cost :-The part of development cost incurred in making a trial production as preliminary to formal production is called pre-production cost.

Main Considerations :-

In view of the above difficulties and suggestions, following should be the main considerations while introducing a costing system in a manufacturing organization:

1. Product :-The nature of a product determines to a great extent the type of costing system to be adopted. A product requiring high value of material content requires an elaborate system

·         of materials control. Similarly, a product requiring high value of labor content requires an efficient time keeping and wage systems. The same is true in case of overheads.

2. Organization :-The existing organization structure should be distributed as little as possible. It becomes, therefore, necessary to ascertain the size and type of organization before introducing the costing system.

3.Objective :-The objectives and information which management wants to achieve and acquire should also be taken care of. For example, if a concern wants to expand its operations, the system of costing should be designed in a way so as to give maximum attention to production aspect. On the other hand, if a concern were not in a position to sell its products, the selling aspect would require greater attention.

4. Technical Details :-The system should be introduced after a detailed study of the technical aspects of the business. Efforts should be made to secure the sympathetic assistance and support of the principal members of the supervisory staff and workmen.

Methods of Costing:-

Costing can be defined as the technique and process of ascertaining costs. The principles in every method of costing are same but the methods of analyzing and presenting the costs differ with the nature of business. The methods of job costing are as follows:

1. Job Costing :-The system of job costing is used where production is not highly repetitive and in addition consists of distinct jobs so that the material and labor costs can be identified by order number. This method of costing is very common in commercial foundries and drop forging shops and in plants making specialized industrial equipments. In all these cases, an account is opened for each job and all appropriate expenditure is charged thereto.

2. Contract Costing :-Contract costing does not in principle differ from job costing. A contract is a big job whereas a job is a small contract. The term is usually applied where large-scale contracts are carried out. In case of ship-builders, printers, building contractors etc., this system of costing is used. Job or contract is also termed as terminal costing.

3. Cost Plus Costing :-In contracts where in addition to cost, an agreed sum or percentage to cover overheads and fit is paid to a contractor, the system is termed as cost plus costing. The term cost here includes materials, labor and expenses incurred directly in the process of production. The system is used generally in cases where government happens to be the party to give contract.

4.Batch Costing :-This method is employed where orders or jobs are arranged in different batches after taking into account the convenience of producing articles. The unit of cost is a batch or a group of identical products instead of a single job order or contract. This method is particularly suitable for general engineering factories which produce components in convenient economic batches and pharmaceutical industries.

5. Process Costing :-If a product passes through different stages, each distinct and well defined, it is desired to know the cost of production at each stage. In order to ascertain the same, process costing is employed under which a separate account is opened for each process.

 e.g., chemical manufacture, paints, foods, explosives, soap making etc.

6.Operation Costing:- Operation costing is a further refinement of process costing. The system is employed in the industries of the following types:

v  The industry in which mass or repetitive production is carried out

v  The industry in which articles or components have to be stocked in semi-finished stage to facilitate the execution of special orders, or for the convenience of issue for later operations

The procedure of costing is broadly the same as process costing except that in this case, cost unit is an operation instead of a process. For example, the manufacturing of handles for bicycles involves a number of operations such as those of cutting steel sheets into proper strips molding, machining and finally polishing.

Techniques of Costing :-

Besides the above methods of costing, following are the types of costing techniques which are used by management only for controlling costs and making some important managerial decisions. As a matter of fact, they are not independent methods of cost finding such as job or process costing but are basically costing techniques which can be used as an advantage with any of the methods discussed above.

1. Marginal Costing :-Marginal costing is a technique of costing in which allocation of expenditure to production is restricted to those expenses which arise as a result of production, e.g., materials, labor, direct expenses and variable overheads. Fixed overheads are excluded in cases where production varies because it may give misleading results. The technique is useful in manufacturing industries with varying levels of output.
2. Direct Costing :-The practice of charging all direct costs to operations, processes or products and leaving all indirect costs to be written off against profits in the period in which they arise is termed as direct costing. The technique differs from marginal costing because some fixed costs can be considered as direct costs in appropriate circumstances.
3.  Absorption or Full Costing :-The practice of charging all costs both variable and fixed to operations, products or processes is termed as absorption costing.

4. Uniform Costing :-A technique where standardized principles and methods of cost accounting are employed by a number of different companies and firms is termed as uniform costing. Standardization may extend to the methods of costing, accounting classification including codes, methods of defining costs and charging depreciation, methods of allocating or apportioning overheads to cost centers or cost units. The system, thus, facilitates inter- firm comparisons, establishment of realistic pricing policies, etc.

Systems of Costing :-

It has already been stated that there are two main methods used to determine costs. These are:

v  Job cost method

v  Process cost method

It is possible to ascertain the costs under each of the above methods by two different ways:

v  Historical costing

v  Standard costing

Historical Costing :-

Historical costing can be of the following two types in nature:

v  Post costing

v  Continuous costing

Cost in Short & Long Run

 by Bharti Garg  (2910022)

INTRODUCTION 

In microeconomics, the long run is the conceptual time period in which there are no fixed factors of production as to changing the output level by changing the capital stock or by entering or leaving an industry. The long run contrasts with the short run, in which some factors are variable and others are fixed, constraining entry or exit from an industry. In macroeconomics, the long run is the period when the general price level, contractual wage rates, and expectations adjust fully to the state of the economy, in contrast to the short run when these may not fully adjust.

In the long run, firms change production levels in response to (expected) economic profits or losses, and the land, labor, capital goods and entrepreneurship vary to reach associated long-run average cost. In the simplified case of plant capacity as the only fixed factor, a generic firm can make these changes in the long run:

·        enter an industry in response to (expected) profits

·        leave an industry in response to losses

·        increase its plant in response to profits

·        decrease its plant in response to losses.

Long-run average-cost curve with economies of scale to Q2 and diseconomies of scale thereafter.

The long run is associated with the long-run average cost (LRAC) curve in microeconomic models along which a firm would minimize its average cost (cost per unit) for each respective long-run quantity of output. Long-run marginal cost (LRMC) is the added cost of providing an additional unit of service or commodity from changing capacity level to reach the lowest cost associated with that extra output. LRMC equalling price is efficient as to resource allocation in the long run. The concept of long-run cost is also used in determining whether the long-run expected to induce the firm to remain in the industry or shut down production there. In long-run equilibrium of an industry in which perfect competition prevails, the LRMC = Long run average LRAC at the minimum LRAC and associated output. The shape of the long-run marginal and average costs curves is determined by economies of scale.

The long run is a planning and implementation stage. Here a firm may decide that it needs to produce on a larger scale by building a new plant or adding a production line. The firm may decide that new technology should be incorporated into its production process. The firm thus considers all its long-run production options and selects the optimal combination of inputs and technology for its long-run purposes. The optimal combination of inputs is the least-cost combination of inputs for desired level of output when all inputs are variable.[3] Once the decisions are made and implemented and production begins, the firm is operating in the short run with fixed and variable inputs.

All production in real time occurs in the short run. The short run is the conceptual time period in which at least one factor of production is fixed in amount and others are variable in amount. Costs that are fixed, say from existing plant size, have no impact on a firm's short-run decisions, since only variable costs and revenues affect short-run profits. Such fixed costs raise the associated short-run average cost of an output level over the long-run average cost if the amount of the fixed factor is better suited for a different output level. In the short run, a firm can raise output by increasing the amount of the variable factor(s), say labor through overtime.

A generic firm already producing in an industry can make three changes in the short run as a response to reach a posited equilibrium:

·        increase production

·        decrease production

·        shut down.

In the short run, a profit-maximizing firm will:

·        increase production if marginal cost is less than marginal revenue (added revenue per additional unit of output;

·        decrease production if marginal cost is greater than marginal revenue;

·        continue producing if average variable cost is less than price per unit, even if average total cost is greater than price;

·        shut down if average variable cost is greater than price at each level of output.

The transition from the short run to the long run may be done by considering some short-run equilibrium that is also a long-run equilibrium as to supply and demand, then comparing that state against a new short-run and long-run equilibrium state from a change that disturbs equilibrium, say in the sales-tax rate, tracing out the short-run adjustment first, then the long-run adjustment. Each is an example of comparative statics. Alfred Marshall (1890) pioneered in comparative-static period analysis. He distinguished between the temporary or market period (with output fixed), the short period, and the long period. "Classic" contemporary graphical and formal treatments include those of Jacob Viner (1931), John Hicks (1939),and Paul Samuelson (1947).

The law of diminishing marginal returns to a variable factor applies to the short run.  It posits an effect of decreased added or marginal product of from variable factors, which increases the supply price of added output. The law is related to a positive slope of the short-run marginal-cost curve.

The usage of 'long run' and 'short run' in macroeconomics differs somewhat from the above microeconomic usage. J.M. Keynes (1936) emphasized fundamental factors of a market economy that might result in prolonged periods away from full-employment.  In later macro usage, the long run is the period in which the price level for the economy is completely flexible as to shifts in aggregate demand and aggregate supply. In addition there is full mobility of labor and capital between sectors of the economy and full capital mobility between nations. In the short run none of these conditions need fully hold. The price is sticky or fixed as to changes in aggregate demand or supply, capital is not fully mobile between sectors, and capital is not fully mobile to interest rate differences among countries & fixed exchange rates.

A famous critique of neglecting short-run analysis was by John Maynard Keynes, who wrote that "In the long run, we are all dead," referring to the long-run proposition of the quantity theory of, for example, a doubling of the money supply doubling the price level.

Is a direct labor rate a variable cost or a fixed cost?

Labor is always a variable cost, even if it is contracted labor. Fixed cost is defined as any expenses you would still have if you shut everything down. For example, if a factory shuts down, they would still have payments on their equipment. Variable costs are costs that increase or decrease with production. So labor, raw materials, etc are variable costs. This holds true in both the short & long term, despite what others have posted here.