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This document defines and explains different types of costs that are important for businesses to consider in their production and pricing decisions. It outlines 6 main categories of costs: 1) opportunity vs actual costs, 2) explicit vs implicit costs, 3) out of pocket vs book costs, 4) replacement vs historical costs, 5) private vs social costs, and 6) incremental vs sunk costs. For each, it provides examples to illustrate the distinction between the types of costs. The overall purpose is to introduce important cost concepts to help with production management, cost minimization, determining optimal output levels and prices.
This document defines and explains different types of costs that are important for businesses to consider in their production and pricing decisions. It outlines 6 main categories of costs: 1) opportunity vs actual costs, 2) explicit vs implicit costs, 3) out of pocket vs book costs, 4) replacement vs historical costs, 5) private vs social costs, and 6) incremental vs sunk costs. For each, it provides examples to illustrate the distinction between the types of costs. The overall purpose is to introduce important cost concepts to help with production management, cost minimization, determining optimal output levels and prices.
This document defines and explains different types of costs that are important for businesses to consider in their production and pricing decisions. It outlines 6 main categories of costs: 1) opportunity vs actual costs, 2) explicit vs implicit costs, 3) out of pocket vs book costs, 4) replacement vs historical costs, 5) private vs social costs, and 6) incremental vs sunk costs. For each, it provides examples to illustrate the distinction between the types of costs. The overall purpose is to introduce important cost concepts to help with production management, cost minimization, determining optimal output levels and prices.
constitutes its cost of production Cost Function - C = f (q ) , Cost function is a derived function derived from production function. Importance of cost concepts Locating the weak points in production management Minimizing the costs Finding the optimum level of output Determining price and dealers, margin Estimating or projecting the cost of business operation
COST CONCEPTS 1. Opportunity cost and actual cost - Opportunity cost is the cost of the opportunity lost. It is the income which could have been earned if the scarce resources were used in the next best alternative Also called Alternative cost Actual costs mean the expenditure incurred for acquiring or producing a good or a service They are recorded in the book of accounts Also called as Outlay or Absolute cost
2. Actual or Explicit costs and Implicit or Imputed costs Actual costs are those which are actually incurred by the firm in payment for labour, material, plant, building, machinery etc They enter the book of accounts Implicit costs are those costs which actually do not take the form of cash outlays, nor do they appear in the accounting system
3. Out of pocket and book costs Out -of -cost are those that involve immediate payment to outsiders Book costs that do not require current cash expenditure 4. Replacement and Historical Costs Historical cost refers to the cost incurred in the past on the aquisition of productive assets Replacement costs refer to the outlay that has to be made for replacing an old asset Instability in prices make the two differ from each other
5. Private and Social costs The costs which are related to the working of the firm and are used in the cost benefit analysis of business decisions are called private costs Social costs are not explicitly borne by the firms but they arise due to the functioning of the firm. They do not figure in the business decisions normally. Such costs are borne by the society. They are not paid for by the firm. E.g. Mathura oil refinery discharging its wastage in Yamuna river Therefore social costs are those which refer to the total costs borne by the society due to production of a commodity . Social costs includes the cost of resources for which the firm is not supposed to pay i.e. atmosphere, rivers, and also for use of public utility services like roadways, drainage system etc. 6. Incremental costs and sunk costs Incremental costs are closely linked to the concept of Marginal cost . But while Marginal cost refers to the cost of marginal unit of output, Incremental costs refers to the total additional cost associated with the decision to expand the output or add a new variety of product etc. This concept is useful because, it is based on the fact that in real world, it is not practicable (for lack of perfect divisibility of inputs) to employ factors for each unit of output seperately
Sunk cost are those which are made once and for all and cannot be altered, increased, or decreased, by varying the rate of output, nor can they be recovered. the reason such costs are based on prior commitment and cannot be revised or reversed or recovered when there is a change in market conditions or change in business decisions. E.g. all the preceding costs which are already undertaken are considered to be sunk costs. Difference between Fixed and Sunk cost Fixed Costs are costs that are paid by a firm that is in business, regardless of the level of output it produces. E.g. Salaries of the key executives and expenses for their office space and support staff. Fixed costs can be avoided if the firm goes out of business E.g. the key executives will no longer be needed Sunk costs are the costs that have been incurred and cannot be recovered. E.g. cost of a factory with specialised equipment that is of no use in another industry