 |
| Cost in Economics | IndianTechnoEra |
Cost
A cost is the value of money that has been used up to produce something.
Definition of Cost
The expenses faced by the business in the process of supplying goods and services to consumer
Types of cost
- Opportunity cost and actual cost
- Direct and indirect cost
- Explicit and implicit cost
- Historical and replacement cost
- Fixed cost and variable cost
- Real and prime cost
- Total , average and marginal cost
- Opportunity cost and Actual cost
Opportunity and Actual Cost
What is Opportunity cost?
Cost incurred for loosing next best alternative
What is Actual cost?
An actual amount paid or incurred, as opposed to estimated cost or standard cost.
Applications of Opportunity Cost
The concept of opportunity cost has been widely used by modern economists in various fields. The main applications of the concept of opportunity cost are as follows —
(i) Determination of factor prices- The factors of production need to be paid a price that is at least equal to what they command for alternative uses. If the factor price is less than factor's opportunity cost, the factor will quit and get employed in the better-paying alternative(ii) Determination of economic rent - The concept of opportunity cost is widely used by modern economists in the determination of economic rent. According to them economic rent is equal to the factor's actual earning minus its opportunity cost (or transfer earnings).
(iii) Decisions regarding consumption pattern - The concept of opportunity cost suggests that with given money income, if a consumer chooses to have more of one thing, he has to have more of one thing, he has to have less of the other. He cannot increase the consumption of all the goods simultaneously.
(iv) Decisions regarding production plan - With given resources and given technology if a producer decides to produce greater amount of one commodity, he has to sacrifice some amount of another commodity. Thus on the basis of opportunity costs a firm makes decisions regarding its production plan.
(v) Decisions regarding national priorities - With given resources at its command a country has to plan the production of various commodities. The decision will depend on national priorities based on opportunity costs.
Explicit and Implicit cost
What is Explicit cost?
Explicit cost refers to the money expended to buy or hire resources from outside the organization for the process of production .
What is Implicit cost?
Implicit cost refers to the cost of use of the self owned resources of organization that are used in production
Direct and Indirect cost
What is Direct Cost?
Direct costs are those cost that have directly accountable to specific cost object such as a process or product
Ex: wages paid ,salary paid labor, material…etc
What is Indirect cost?
Indirect cost are those costs which are not directly accountable to specific cost object or not directly related to production
Ex: insurance, maintenance ,telecom, ….etc
Historical and Replacement cost
What is Historical cost?
Historical cost refers to the original (actual) cost incurred at the time the asset was acquired
What is Replacement cost?
The replacement cost is the price that an entity would pay to replace an existing assets at current market price that may not be market value of that asset
Fixed and variable cost
What is Fixed cost?
Fixed cost is the cost that remains unchanged irrespective of the output level or sales revenue such as interest, rent , salaries etc.
What is Variable cost?
Variable cost are those costs that vary depending on a company’s production volume; they raise as production increases and fall as production decreases
Real cost and Prime cost
What is Real cost?
Real cost of a production refers to the physical quantities of various factors used in producing commodity Ex: Real cost of a table composes of a carpenter’s labor to cubic feet of a wood ,a dozen of nails, half a bottle of varnish…..etc “
Real cost thus signifies the aggregate of real productive resources absorbed in the production”
What is Prime cost?
Prime cost The direct cost of commodity in terms of the materials and labor involved in its production excluding fixed cost By calculating prime cost the firm can decide how much should be their selling price to earn profit
Short Run & Long Run Cost Function
What is Short Run Cost Function?
Economists have treated cost as a function of output both in short run and long run.
In the short run, capital, land, factors prices, technology etc remain fixed. Hence, short run cost function can be written as where C is cost of production Q is Output (total output) R, are capital and other fixed factor is factor prices is given technology.
Thus short run cost function can be written as
What is Long Run Cost Function?
The long run cost function can be written as Where C is cost of production Q is output T is technology K is capital Prof is factor prices In studying the relationship between long run cost and level of output in a two dimensional diagram, we keep technology and output as constant.
Thus , long run cost function, traditionally, is written as
Time Element And Cost
Time element has an important place in the analysis of cost of production. In the theory of supply we usually take three kinds of time-period. They are:
(i) Very Short-period - Very short-period is defined as the period of time which is so short that the output cannot be adjusted with the change in demand. In this period, the supply of a commodity is limited to its stock, hence during this period supply remains fixed.
(ii) Short Period - Short period is defined as the period of time during which production can be varied only by changing the quantities of variable factors and not of fixed factors; Land, factory building, heavy capital equipment, services of management of high category are some of the factors that cannot be varied in a short period. That is why they are called fixed factors. There are some factor-inputs that can be varied as and when required. They are called variable factors. For instance, power, fuel, labour, raw materials, etc. are the examples of variable factor inputs.
(iii) Long Period - Long period is defined as the period which is long enough for the inputs of all factors of production to be varied. In this period no factor is fixed, but all are variable factors.
Define the term Total cost
Total cost : it is the cost refers to the total expenses incurred in reaching a particular level of output
TC = TVC + TFC
TVC=VC/Q
TFC=FC/Q
Possible Shapes of the Total Cost Curve
Total Variable and Fixed Costs
Variable and Fixed Costs Per Unit
Average Cost
Average cost is the total cost divided by total units of output .Where Q is the quantity produced
Average Fixed Cost /Average variable cost
- Average fixed cost (AFC)
- Average fixed cost is the total fixed cost divided by total units of output TFC/Q =AFC Where Q is the number of units produced
- Average Variable cost
- Average variable cost is total variable cost divided by quantity produced AVC =TVC/ Q Where Q is the quantity produced
Marginal cost (MC)
The marginal cost is also per unit cost of production. It is the addition made to the total cost by producing one more unit of output.
MCn = TCn – TCn-1
The marginal cost of the unit of output is the total cost of producing n units minus the total cost of producing n-1 (i.e …one less in the total) units of output
Economies of the Scale of Production
According to Stinger, Economies of scales is synonyms of returns to scale. When scale of production is increased, up to a point, one gets economies of scale. Therefore, diseconomies of scale follow. Increasing returns to scale is the result of these economies.
Marshall has divided economies of scale into two parts :
Internal & External Economies
Internal economies of scale
Are those economies which are internal to the firm. These arise within the firm as a result of increasing the scale of output of the firm. A firm secures these economies from the growth of the firm independently.
The main internal economies are grouped under the following heads:
- Technical Economies
- Managerial Economies
- Marketing Economies
- Financial Economies
- Risk Bearing Economies
- Economies of Scale
External economies of scale
Are those economies which are not specially availed of by any firm. Rather these accrue to all the firms in an industry as the industry expands.
The main external economies are as under:
- Diseconomies of pollution
- Excessive pressure on transport facilities
- Rise in the prices of the factors of production
- Scarcity of funds
- Marketing problems of the products
- Increase in risks
Bibliography / references
- Managerial Economics, GS Gupta, Tata-McGraw Hill, 2007
- Principles of Economics, DN Dwivedi, Prentice Hall India, 2004
- Economics, R L Varshney and KL Maheshwari, Sultan Chand & Sons, 2005
- Modern Economic Theory, KK Dewett, S. Chand & Company Ltd, 2005
- Managerial Economics, Dr. MS Subrahmanian, Ramesh Publications, 1995
Key: Agenda, Meaning of Cost, Types of Cost, Short Run Cost Functions, Long Run Cost Functions, Define the term Total cost, Define the term Average cost, Define the term Marginal cost,Cost: Concept of costs, short and long-run cost functions.