COST

ANALYSIS
Cost analysis
• Cost normally considered from the producer’s or firm’s
point of view
• In producing a commodity / service a firm has to
employ as aggregate of various factors of production
• These factors are to be compensated by the firm for
their efforts or contribution made in producing the
commodity, this compensation (usually in terms of
factor price) is the cost
• Thus the cost of production of a commodity is the
aggregate of price paid for the factors of production
used in producing that commodity
• Cost of production, therefore, denotes the value of the
factors of production employed
• Value of inputs required in the production of a
commodity determines the cost of output
• Cost may be real cost or opportunity cost
Various cost concepts
1. Real cost
Real cost of production of a commodity
refers to the exertion of labour,
sacrifice involved in the abstinence
from present consumption by the
savers to supply capital, and social
effects of pollution, congestion &
environmental distortions
2. Opportunity cost
• The opportunity cost of producing
certain commodity is the sacrifice of the
next best alternative forgone in the use
of productive resources.
• The opportunity / alternative cost of one
unit of product A is the amount of
product B that has been sacrificed by
allocating the resources to produce A
rather than B.
Importance of the concept of
opportunity cost
• Determination of relative prices of goods
• Determination of normal remuneration to a
factor
• Decision making & efficient resource
allocation
3. Money Cost
• Cost of production measured in terms of
money.
• Money cost is the monetary expenditure on
inputs of various kinds-raw materials, labour,
etc., which is required for the best output.
Types of cost
• Explicit & Implicit costs
• Accounting & Economic costs
• Fixed costs & Variable costs
• Direct Costs & Indirect costs
• Private costs & Social costs
• Relevant costs & Irrelevant costs
• Separate costs & common costs
Explicit & Implicit costs
• Explicit costs are direct contractual
monetary payments incurred through
market transactions.
E.g., Costs of raw materials, wages &
salaries, rent of factory, etc.
• Implicit costs are the opportunity costs of
the use of factors which a firm does not
buy or hire but already owns it.
E.g., Interest on capital supplied by him,
Rent of land & premises belonging to
entrepreneur himself, etc.
Accounting & Economic costs
• Accounting costs are those costs where
the accountant of the organization
considers to be explicit costs even it
belongs to the entrepreneur itself. E.g.,
Interest on capital, place, etc.
• Economic costs, the economist of the
organization includes both explicit &
implicit costs, for its calculation
purposes E.g., salaries & wages, place
belongs to the owner itself.
Fixed & supplementary costs
• In short-term run fixed factors are
unalterable, therefore prices paid for the
fixed factors termed as Fixed costs
(Supplementing costs).
E.g., machineries, factory building, etc.
• In short-term run variable factors tends
to keep varying, therefore prices paid for
the variable factors termed as Variable
costs (Prime costs).
E.g., labour, prices of raw materials, etc.
Types of production costs &
their Measurement
• Total Cost (TC)
– Is the aggregate of expenditures incurred
by the firm in producing a given level of
output
– If the Pf is Q = f (a,b,c, …n), then total cost
TC = f (Q)
– TVC = TFC + TVC
• Total Fixed Cost (TFC)
– TFC remains at level in the short-run
• Total Variable Cost (TVC)
– It is the increasing function of the output
Types of production costs &
their Measurement cont..
• Average Fixed Cost (AFC)
– AFC = TFC / Q
• Average Variable Cost (AVC)
– AFC = TVC / Q
• Average Total Cost (ATC) or Average Cost
(AC)
– ATC or AC = TC / Q or TFC + +TVC / Q =
TFC/Q + TVC/Q
– ATC = AFC + AVC
• Marginal Cost (MC)
– Is the cost of producing extra unit of output
– MC = δ TC / δ Q