Various Concepts of Costs

Meaning of Cost

In price theory, the idea of a firm's cost is crucial. The phrase "cost" or "cost of production of the commodity" refers to the sum of all incurred costs, as well as the imputed cost and the usual profit anticipated by the producer. Costs are simply the expenses incurred during the production of any form of goods.

Cost Function

When goods or services are created, a number of costs must be incurred, including the purchase of raw materials, paying laborers for their labor, paying the landlord for the factory's space, paying the capitalist back for the money he or she borrowed, etc. Cost function is the name given to the mathematical expression of the relationship between output and cost, while cost curve is the name given to the related diagrammatic representation. Functions that are derived from costs exist. They come from the function of production.

Algebraically, the cost function is written as:
C = f (Q) where, C = cost , f = Function , Q = output
Generally, a cost is the increasing function of output.

Determinants of Cost Function

The determinants of cost function are mainly two:

• Production function
• Prices of outputs

Various Concepts of Costs

• Money costs: The expenditures incurred by the company when procuring or retaining productive services are known as money costs. These costs consist of:

  • Any kind of rental costs incurred for property, equipment, and structures.
  • Paid to laborers in wages and salaries.
  • Any and all costs incurred while buying machinery, equipment, and raw materials.
  • Interest for loans.
  • Other financial costs.

The company enters the real monetary costs incurred for the factors of production on its debit items in the accounting records.

• Explicit costs and implicit costs: Explicit expenses are the financial fees that the company must pay to the providers of different factor services. These expenses are the monetary sums that a company pays to outside parties who provide labor, materials, fuels, transportation, power, and other services. In other words, the company's real financial outlays for the factor service purchases are the only costs that may be considered explicit (or the economic reward which is paid to the suppliers of factor services by a firm). There are some crucial services that the business owner alone owns and renders without receiving payment. Such self-owned or self-employed resources have implicit costs associated with them. For instance, the business owner might offer his own land and money as well as managerial and entrepreneurial skills to the company. As a result, he has the right to receive payments for his managerial services, interest on the cash he provided, and rent on his land. However, it is also necessary to calculate the cost. However, since no outside parties are compensated, these expenditures are not readily apparent. These expenses must be imputed or projected based on the revenue that would be generated by their best alternative uses. Implicit costs, in a nutshell, are the financial payments that self-employed or self-owned resources may have made in their best alternative employments. The opportunity cost is used to evaluate these costs. Indirect costs can be separated into two categories as follows:

• Imputed costs: Imputed costs are the estimated expenses associated with the inputs that a company owns and uses in one of its production units.

• Normal profit: It is described as the very minimum that an entrepreneur must receive in order to be persuaded to take on the risk of the firm. It is a portion of the cost and the minimal supply price for the managerial services.

• Accounting costs and economic costs: When an accountant examines the financial status of a business, he takes only monetary expenses made on factor services owned by outsiders, except the producer, in the calculation. As a result, it solely includes stated costs.Explicit and implicit costs together make up economic costs (i.e. imputed costs and normal profit). These expenses comprise both the actual money spent on inputs that are bought or rented, as well as the assumed worth of the inputs (such as land, labor, and capital) that the entrepreneur owns and provides, together with a typical profit. Accounting cost is equal to explicit cost, often known as money cost, while economic cost is equal to explicit costs plus implicit costs, or accounting cost plus (imputed cost plus normal profit).

• Opportunity cost: Opportunity cost is also known as alternative cost. The opportunity cost of any economic resources can be defined as the value of next best commodity which could have been produced by the use of the same resources that can be used to produce many things. The opportunity cost of producing goods is not any other alternative goods that would be produced with the same resources; rather, it is the next best alternative goods that could be produced with the same resources. In other words, the opportunity cost of any goods is the amount of the next best alternative goods that is given up to produce these goods. Opportunity cost is a notion with significant economic implications. Here are a few of them:
  • Calculating relative prices of goods: For instance, if the same set of elements can be used to create either one automobile or six scooters, the cost of a single car will typically be at least six times higher than that of a single scooter.
  • Calculating a factor's typical compensation: For instance, if a college professor is able to find alternative employment as an officer at a bank for a salary of Rs. 20,000 per month, the college must pay him at least Rs. 20,000 to keep him on staff.
  • Making decisions and distributing resources normally

Accounting Profit and Economic Profit

The accounting profit is the sum of the explicit costs and overall income of the company. However, the whole revenue less all costs, or economic costs, equals economic profit. As a result, when an economist claims that a business can cover its costs (i.e., recover both explicit and implicit costs), the entrepreneur is actually obtaining a return that is merely sufficient to allow him to continue using his skills in the current area of production. It is economic profit or pure profit if an entrepreneur receives a balance over total income less economic costs. In short,
Economic Profit = Total sales receipt – Economic costs
Economic profits are not the part of cost of production

Reference

Koutosoyianis, A (1979), Modern Microeconomics, London Macmillan