Cost Concepts And Cost Behaviours

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Meaning

Cost of production is an influential factor on the supply side. It refers to the expenditure incurred on the various factors of production like land, labour,capital and organization which are used in the production of a commodity. It denotes the remuneration paid to the factors of production for their services. The various cost consents are as follows

Real Cost

Its refer to the actual quantities of various factors used in production a commodity.

For Example :- the real cost of production a chair is the amount of wood, nails, carpenters , labour, etc.

According to Alfred Marshall “the real cost of production should includes the toils, troubles involved, pollution generated, ETC. since this concept is an abstracts one, it is very difficult to measure it precisely”.

Money cost

It is the cost of production expressed in terms of money. It is the money spent on the various resources used in the production process.

Explicit Cost Implicit Cost

Explicit costs are those expenses that are actually paid by the firm (paid-out-costs). They are generally recorded in books of account.

Implicit costs are theoretical expenses in the sense that they go unrecognized by the accounting system. May be defined as the earnings of those employed resources that belong to the owner himself

For E.g. Cost of raw materials, wages and salaries, power charges, transport expenses, etc.This expenditure is actually incurred by the firm. Since they are recorded, they are known as accounting cost

For E.g. The entrepreneur may be using his own land. Rent may not be paid for this. If he had rented it out to somebody he would have earned some rent. This should be considered and some amount of rent should be included in the cost of production.

Explicit Cost And Implicit Cost

Economic Cost And Accounting Cost

Economic Cost Accounting Cost

Unlike accounting costs, economic costs consider both the explicit and implicit costs to the company that occur during the fiscal year. Implicit costs are associated with resources that are provided to the company with no price tag

Accounting costs come from the total explicit costs of the company during the fiscal year. Accounting costs do not include implicit costs resulting from unused resources. Explicit costs with defined monetary values are factored into the accounting costs of the company to calculate net income at the end of the fiscal year.

For example, if a company operates out of a building it owns, it experiences an implicit cost from the rent it could earn from leasing the building to another company. The building could earn $3,000 a month from a commercial renter, so the company has an implicit cost of $3,000 to add to its economic costs.

For example, if the company spends $100,000 on employee wages, $50,000 on equipment purchases and $20,000 on inventory, the total accounting costs are $170,000 for the year.

Fixed Cost And Variable Cost

Fixed Cost Variable CostIt refers to the cost incurred on the fixed factors of production

Its refer to the cost incurred on the variable factors of production

This cost remains constant irrespective of the levels of outputs

It varies with levels of outputs

Even if the outputs is nil, fixed cost will be incurred

This cost will increase /decrease with the levels of outputs.

This is also known as supplementary costs or overhead costs

This is also known as prime costs.

Its includes:a) Rent for the building b) Interest paid on capitalc) Insurance premiumd) Property taxese) Depreciation and maintenance

allowances, etc.

It includes a) Prices of raw materialsb) Wages of laboursc) Excise duties, sales taxd) Transport expenditure Etc.

Historical Cost And Replacement Cost

Historical Cost Replacement Cost

Historical cost states the cost of plant, equipment and materials at the price originally paid for them

Replacement cost means the price that would have to be paid currently for acquiring the same plant.

Private Cost And Social Cost

Private Cost Social Cost

The micro level economic costs. If the decision of a firm to expand Its output leads to increase in its cost, It is private costAre those which are actually incurred Or provided for By an individual or firm For its business activity.

The macro level economic costs. If it leads to certain costs to the society, May be in the nature of Greater pollution, congestion etcSocial cost is the total cost to the society onAccount of production of a good.

Marginal Cost And Incremental Cost

Marginal Cost Incremental Cost

Marginal cost refers to the cost incurred in producing an additional unit of the output.

Incremental costs are defined as the change in overall costs that result from particular decisions being made

For e.g. introducing of new marketing and adverting strategic production of a components of the product instead of outstanding, etc. will affect the total cost

Sunk Cost And Future Cost

Sunk Cost Future Cost

Sunk cost is the one not affected or altered by a change in the level or nature of business activity.

Future costs are the estimates of time adjusted past or present costs and are reasonably expected to be incurred in some future period or periods.

For e.g. when a car is purchased, it can subsequently be resold; however, it will probably not be resold for the original purchase price. The economic loss is the difference (including transaction costs).

Opportunity Cost

An opportunity cost is the sacrifice you make when you use a resource for one purpose instead of another

Opportunity costs are implicit costs that do not appear anywhere in the accounting records

Machine time used to make one product cannot be used to make another, so a product that has a higher contribution margin per unit may not be more profitable if it takes longer to make.

Management accountants often use the concept of opportunity cost

Continued…………

It is useful to a businessman for a number of purpose:-

a) it is useful to determine the relative prices of the different goods.

b) it helps in determining the normal earning of a factor. If the factor has to be retained in the present job, it should be paid atleast the amount it can get in the next best job.

c) it helps in decision-making and optimum allocation.

While analysing the cost data of a firm, the following types of costs are considered

Total Cost(TC):- It is the total expenditure incurred by the firm inproduction a given level of output. It is obtained by multiplying factor prices with their quantities. Symbolically it is expressed as TC=f (Q)(which implies that total cost varies with output.

Total Fixed Cost:- it is the total cost incurred on the fixed factors of production. TFC remains same at all levels of output in the short run.

Total Variable Cost:- In the short run some factors are variable.The cost incurred on these variable factors is called total variable cost.

Average fixed Cost (AFC):- AFC is the total fixed cost divided bytotal units of the output. i.e. AFC=TFC. AFC is the fixed cost per unitof the output. Q

Average Variable Cost:- it is the total fixed cost divided by the total units of output.

AVC=TVC. It is the variable cost per unit of output Q

Continued………………

Average Total Cost (ATC):- It is total cost divided by the units of output. ATC=TC.

Q It is the average cost per unit of the output. It can also be

calculated as the sum of the average fixed and average variable cost.

Marginal Cost:- it is cost of production an extra unit of the output. It is calculated as MC=TCn – TCn-1 i.e. Total cost of producing n unit of the output-total cost of producing (n-1) unit of the output.

the above cost concept can be explained with the help of the following table:-

Short Run And Long Run Cost Curves

The TFC, TVC, AND TC curves in the short run can be as follows:-

In this table the TFC curves is a

horizontal straight line indicating

that whatever be the level of

output, TFC will remain the same.

The TVC curve starts from the

origin. Initially it rise gradually

and then becomes steeper

denoting a sharp rise in total

variable cost.

Continued…………..

The AVC, ATC,AFC and MC curves in the short run are represented as follows:

In this graph the AFC curve is

a rectangular hyperbola. It

implies that total fixed cost is

constant throughout. The AFC

keeps falling. It indicates that

fixed costs are spread out

when output is increased.

Relationship between average and marginal cost

Average cost is calculated by dividing total cost by the number of units produced while marginal cost is an increase in total cost resulting from an increase of one unit in production. If average cost is falling, marginal cost will fall more sharply. If average cost is increase, marginal cost will increase more sharply.

0

500

1000

1500

2000

2500

0 5 10

MC

AC

Optimum Production Capacity

P

Unit Of Production

Cost

Rs

In the above diagram, unit of production have been

shown on X-axis and costs on Y-axis.AC is average

cost curve. MC is marginal cost curve and P is the point

at which MC and AC intersect each other. Diagram

makes it clear that when AC falls more sharply and

when AC increase, MC increase more sharply. MC cuts

AC curve when AC.

Long Run Average Cost Curve(LAC)

Meaning:-

Long run average cost means total cost means total long-run cost divided by the number of units produced. Long-run average cost t different levels of production. it can be illustration with the help of diagram.

o

A

B

C

D

E G

F

M1 M2 M3 M4

SAC1SAC2

SAC3

Optimum Production Point

Minimum Cost Point

Y

X

Unit Of Production

In diagram quantity of production has

been presented on x-axis and the

cost of production has been

presented on y-axis. The diagram is

based on the assumption that there

are only three plan of production

available with the firm large medium

and small. Short-run average cost

curves of these plans have been

presented as SAC1, SAC2,SAC3. In

long- run, the firm will have to select

any one of these three plans.

Suppose the firm decides to produce

OM1 quantity of production, the firm

will have to use SAC1 and its

average cost will be AM1. Though the

firm can use SAC2 also to produce

the same quantity but in this case its

cost will be BN1. Which is more than

AM1. therefore the firm will be SAC1

to get OM1 quantity of production and

its average cost will be AM1. since

EM3 is the minimum cost. Therefore,

the firm must produce OM3 quantity

of production at SAC2. It will be the

optimum point of production.

Optimum Firm

In the diagram, the LAC curve is enveloping a number of short run average cost

curve. The firm is said to be optimum when it employs the plant SAC2 it produce OQ

level of output at the minimum cost of production. Here the minimum point of SAC

and LAC coincide with each other. Thus an optimum firm is one which produce at

the minimum point of the long run average cost curve.

The Learning Curve.

This concept is of recent origin. It was developed by the economist Arrow.

According to him, a firm learns through experience uses the resources in the possible manner and lowers the cost of production.

This termed by him as “Learning By Doing”.

Here, the learning curve slopes downward indicates

the declines in the cost as the output increase

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