UNIT 3
Q.1 Cost classification
Types of Costs
A list and definition of different types of economic costs.
Fixed Costs (FC) The costs which don’t vary with changing output. Fixed costs might
include the cost of building a factory, insurance and legal bills. Even if your output
changes or you don’t produce anything, your fixed costs stay the same. In the above
example, fixed costs are always £1,000.
Variable Costs (VC) Costs which depend on the output produced. For example, if you
produce more cars, you have to use more raw materials such as metal. This is a
variable cost.
Semi-Variable Cost. Labour might be a semi-variable cost. If you produce more cars,
you need to employ more workers; this is a variable cost. However, even if you didn’t
produce any cars, you may still need some workers to look after an empty factory.
Total Costs (TC) = Fixed + Variable Costs
Marginal Costs – Marginal cost is the cost of producing an extra unit. If the total cost of
3 units is 1550, and the total cost of 4 units is 1900. The marginal cost of the 4th unit is
350.
Opportunity Cost – Opportunity cost is the next best alternative foregone. If you invest
£1million in developing a cure for pancreatic cancer, the opportunity cost is that you
can’t use that money to invest in developing a cure for skin cancer.
Economic Cost. Economic cost includes both the actual direct costs (accounting
costs) plus the opportunity cost. For example, if you take time off work to a training
scheme. You may lose a weeks pay of £350, plus also have to pay the direct cost of
£200. Thus the total economic cost = £550.
Accounting Costs – this is the monetary outlay for producing a certain good.
Accounting costs will include your variable and fixed costs you have to pay.
Sunk Costs. These are costs that have been incurred and cannot be recouped. If you
left the industry, you could not reclaim sunk costs. For example, if you spend money on
advertising to enter an industry, you can never claim these costs back. If you buy a
machine, you might be able to sell if you leave the industry. See: Sunk cost fallacy
Avoidable Costs. Costs that can be avoided. If you stop producing cars, you don’t
have to pay for extra raw materials and electricity. Sometimes known as an escapable
cost.
Explicit costs – these are costs that a firm directly pays for and can be seen on the
accounting sheet. Explicit costs can be variable or fixed, just a clear amount.
, Implicit costs – these are opportunity costs, which do not necessarily appear on its
balance sheet but affect the firm. For example, if a firm used its assets, like a printing
press to print leaflets for a charity, it means that it loses out on revenue from producing
commercial leaflets.
Q.2 Cost output relations
A proper understanding of the nature and behaviour of costs is a must for regulation
and control of cost of production. The cost of production depends on money forces and
an understanding of the functional relationship of cost to various forces will help us to
take various decisions. Output is an important factor, which influences the cost.
The cost-output relationship plays an important role in determining the optimum level of
production. Knowledge of the cost-output relation helps the manager in cost control,
profit prediction, pricing, promotion etc. The relation between cost and its determinants
is technically described as the cost function.
C= f (S, O, P, T ….)
Where;
C= Cost (Unit or total cost)
S= Size of plant/scale of production
O= Output level
P= Prices of inputs
T= Technology
Considering the period, the cost function can be classified as (1) short-run cost function
and (2) long-run cost function. In economics theory, the short-run is defined as that
period during which the physical capacity of the firm is fixed and the output can be
increased only by using the existing capacity allows to bring changes in output by
physical capacity of the firm.
1. Cost-Output Relationship in the Short-Run
The cost concepts made use of in the cost behavior are Total cost, Average cost, and
Marginal cost.
is the actual money spent to produce a particular quantity of output. Total Cost is the
summation of Fixed Costs and Variable Costs.
Q.1 Cost classification
Types of Costs
A list and definition of different types of economic costs.
Fixed Costs (FC) The costs which don’t vary with changing output. Fixed costs might
include the cost of building a factory, insurance and legal bills. Even if your output
changes or you don’t produce anything, your fixed costs stay the same. In the above
example, fixed costs are always £1,000.
Variable Costs (VC) Costs which depend on the output produced. For example, if you
produce more cars, you have to use more raw materials such as metal. This is a
variable cost.
Semi-Variable Cost. Labour might be a semi-variable cost. If you produce more cars,
you need to employ more workers; this is a variable cost. However, even if you didn’t
produce any cars, you may still need some workers to look after an empty factory.
Total Costs (TC) = Fixed + Variable Costs
Marginal Costs – Marginal cost is the cost of producing an extra unit. If the total cost of
3 units is 1550, and the total cost of 4 units is 1900. The marginal cost of the 4th unit is
350.
Opportunity Cost – Opportunity cost is the next best alternative foregone. If you invest
£1million in developing a cure for pancreatic cancer, the opportunity cost is that you
can’t use that money to invest in developing a cure for skin cancer.
Economic Cost. Economic cost includes both the actual direct costs (accounting
costs) plus the opportunity cost. For example, if you take time off work to a training
scheme. You may lose a weeks pay of £350, plus also have to pay the direct cost of
£200. Thus the total economic cost = £550.
Accounting Costs – this is the monetary outlay for producing a certain good.
Accounting costs will include your variable and fixed costs you have to pay.
Sunk Costs. These are costs that have been incurred and cannot be recouped. If you
left the industry, you could not reclaim sunk costs. For example, if you spend money on
advertising to enter an industry, you can never claim these costs back. If you buy a
machine, you might be able to sell if you leave the industry. See: Sunk cost fallacy
Avoidable Costs. Costs that can be avoided. If you stop producing cars, you don’t
have to pay for extra raw materials and electricity. Sometimes known as an escapable
cost.
Explicit costs – these are costs that a firm directly pays for and can be seen on the
accounting sheet. Explicit costs can be variable or fixed, just a clear amount.
, Implicit costs – these are opportunity costs, which do not necessarily appear on its
balance sheet but affect the firm. For example, if a firm used its assets, like a printing
press to print leaflets for a charity, it means that it loses out on revenue from producing
commercial leaflets.
Q.2 Cost output relations
A proper understanding of the nature and behaviour of costs is a must for regulation
and control of cost of production. The cost of production depends on money forces and
an understanding of the functional relationship of cost to various forces will help us to
take various decisions. Output is an important factor, which influences the cost.
The cost-output relationship plays an important role in determining the optimum level of
production. Knowledge of the cost-output relation helps the manager in cost control,
profit prediction, pricing, promotion etc. The relation between cost and its determinants
is technically described as the cost function.
C= f (S, O, P, T ….)
Where;
C= Cost (Unit or total cost)
S= Size of plant/scale of production
O= Output level
P= Prices of inputs
T= Technology
Considering the period, the cost function can be classified as (1) short-run cost function
and (2) long-run cost function. In economics theory, the short-run is defined as that
period during which the physical capacity of the firm is fixed and the output can be
increased only by using the existing capacity allows to bring changes in output by
physical capacity of the firm.
1. Cost-Output Relationship in the Short-Run
The cost concepts made use of in the cost behavior are Total cost, Average cost, and
Marginal cost.
is the actual money spent to produce a particular quantity of output. Total Cost is the
summation of Fixed Costs and Variable Costs.
