Money Cost / Accounting Cost / Explicit Cost:
- Money cost refers to money expenses which the firm has to incur in purchasing or hiring the factor services.
These expenses include:
* expenditure of firm on wages and salaries paid to labour,
* expenses incurred on machinery and equipments,
* payments of interest on borrowings,
* rental payments
*payments for raw materials, power etc.
- Since accounting books of a firm records these actual money expenses made by the firm on the factors of production as the cost of production — it is also known as accounting cost or business cost.
- Explicit Cost:
Money payments made by the firm to the owners of various factors services in purchasing and hiring the factor services required in the production of a commodity is known as explicit cost.
- Economic Cost:
Economic cost is the sum total of both explicit cost and implicit cost, including normal profit.
- Implicit Cost or Imputed Cost:
Implicit cost refers to the imputed (estimated) value of inputs owned by the firm and used by it in its own production unit.
- It is the estimated cost of self owned or self employed resources.
- The owner or entrepreneur may own certain factor services which he may use in his own business. Example: his own land, his own capital etc.
Normal Profit :
Normal profit is the minimum payment which a producer must get in order to induce him to undertake the risk involved in production.
It is the minimum supply price of the entrepreneurial services. It is a reward or remuneration for the services of the entrepreneurs.
It is part of the cost of production because unless the entrepreneur expects to get it in the long run, he is not likely to undertake production.
In economics normal profit is a type of cost, actually the cost needed to keep the firm in business.
Thus,
Money cost or Accounting cost = Explicit cost
Economic cost = Explicit cost + Implicit cost (including normal profit)
Opportunity Cost :
Opportunity cost is the cost of producing a particular quantity of a good, is the cost of next best alternative good that could be produced with the same resources and is given up to produce this good.
Here, the cost of producing a particular quantity of a commodity is measured in terms of the quantity of next best alternative commodity that could have been obtained instead, with the same resources.
Application of Opportunity Cost:
There are several applications of the concept of opportunity cost:
1. Making Production Decisions :
The concept of opportunity cost emphasises the problem of choice. Since resources are scarce, they can not be used to produce all the things simultaneously. The decision to produce a particular commodity involves an opportunity cost in terms of the commodities that has to sacrifice in order to produce this commodity.
Opportunity cost indicates the fact that when the society employs resources in a particular way, it is not only making a decision to produce these goods, but it is also the decision of not producing some other goods.
2. Determining National Priorities:
The concept of opportunity cost also affect the government decisions. If the government decides that more resources must be devoted to the production of arms, less will be available to produce civilian goods like butter. Thus, the opportunity cost of defence build up would be a decrease in the production of consumer goods. This is the familiar ‘guns — and — butter’ problem.
If the government decides to construct more roads by cutting down expenditure on the construction of school buildings, the real cost of constructing more roads to the society would be availability of lesser number of schools.
This way, the concept of opportunity cost helps the government to take decisions regarding national priorities.
3. Study Consumer Behaviour :
The concept of opportunity cost can also be applied to the consumer’s behaviour.
Since an individual can not satisfy all his wants due to limited resources in terms of his limited income, he must choose between one thing or the other. The satisfaction of one want involves sacrificing some other want. The real cost of satisfying any want involves sacrificing some other want.
Example, a student who watches a cricket match during school time should see the cost of watching a cricket match in terms of the number of lectures that he would have missed. Opportunity cost is the opportunity missed. Thus the opportunity cost of consuming a commodity influences the consumption decision.
4. Determining the Relative Prices:
Price of a commodity as compared to the prices of other commodities is known as its relative price. The concept of opportunity cost is useful in determining the relative prices of the commodities.
The relative price of a commodity reflects the opportunity cost of producing that commodity. Example, with a given amount of resources, if it is possible to produce either 1 car or 8 scooters, the price of one car will be 8 times that of a scooter. Hence, the opportunity cost of a commodity indicates the relative price of a commodity.
5. Determining Factor Remuneration :
Opportunity cost plays an important role in determining the factor prices. The minimum remuneration which needs be given to a factor equals its opportunity cost.
Example, if a worker ,working in a textile mill as a peon and is earning Rs 10000 per month, that becomes his opportunity cost. Now if an employer in a steel mill wants to employ him as a peon in his mill, he must pay at least Rs. 10000 per month to engage him.
Thus a minimum price that is necessary to retain a factor service in a particular use is its opportunity cost.
Sunk Cost:
A cost incurred in the past and can not be recovered in future is called as Sunk cost. It is called as sunk Becca they are unalterable, unrecoverable and if once invested it should be treated as drowned or disappeared.
Example, if a firm purchases a specialised equipment designed for a special plant, the expenditure on this equipment is a sunk cost because it has no alternative use and its opportunity cost is zero. Sunk cost is also known as “Retrospective Cost”.
Floating Cost:
It refers to all expenses that are directly associated with business activities but not with asset creation. It doesn’t include the purchase of raw material as it is part of current assets. It includes payment like wages to workers, transportation charges, electricity charges and administration.
Floating cost is necessary to run the day to day business of a firm.
Real Cost :
Real cost refers to the efforts and sacrifices made by the owners of the factors of production used in the production of a commodity.
The concept of real cost has no practical significance because it is a subjective concept that makes it difficult to estimate real cost.
Private and Social Cost :
Private Cost:
Private cost refers to the cost of production, incurred by an individual firm in producing a commodity.
Private cost is same as economic cost as far as individual producer, cost includes both the explicit cost as well as the implicit cost.
Social Cost :
Social Cost refers to the cost that the society has to bear on account of the production of a commodity.
Social cost is a wider concept than private cost.
Social cost is the sum of the cost incurred by the producers of goods and services (private cost) and the cost experienced by those who have suffer because of the production of the commodity in terms of external cost.
Social Cost = Private cost + External cost
Example, Oil refinery may discharge its waste in rivers causing water pollution, factories emitting smoke, buses and trucks and vehicles cause both air and noise pollution — such water, air and noise pollution cause health hazards and there by involve cost to the entire society.
Fixed Cost:
Fixed cost is that cost which is incurred on fixed factors.
These are the expenditure , on hiring or purchasing of fixed factors or inputs, which are compulsory and has nothing to do with the amount of production of the good or service.
Example, salary of the permanent staff, interest on the borrowed capital, rent of factory building, depreciation of machinery, expenses for the maintenance of building, property tax, licence fee etc.
Variable Cost :
Variable cost is the cost which is incurred on variable factors.
These are the expenditure on variable factors or inputs, such as labour which can be changed.
Example, expenditure incurred on raw material, wages and salaries paid to casual workers, running expenses like — electricity and taxes of the type of excise duties which depend on the output produced.
Total Cost :
Total cost is the sum of total fixed and total variable cost.
We can also write,
Total Cost (TC) = Total Fixed Cost + Total Variable Cost
Average Cost:
Average total cost or Average cost is the ratio of total cost to the total output.
Average cost is the cost per unit of output.
We can also write,
Average Cost (AC) = Total Cost / Total Output
Marginal Cost:
Marginal cost is defined as increase in the total cost due to increase in one extra unit of output. Increase in total output will lead to increase in total cost of production.
We can also write,
Marginal Cost (MC) = Change in Total Cost / Change in Quantity
Revenue:
Revenue is defined as the amount a person receives by selling a certain quantity of commodity. Revenue can be calculated by multiplying price and quantity of the commodity.
We can write,
Revenue = Price of the commodity × Quantity of the commodity
The total amount of money received by the seller during that time period is called total revenue. Another term used for “total revenue” is total sales proceeds. Because revenue is received by selling a commodity. It is also called total sales proceeds from that commodity.
Total Revenue = Price × Quantity or
TR = P × Q
Average and Marginal Revenue:
Average Revenue (AR) :
Average revenue is simply the revenue earned per unit of the output. In short, it is the price of one unit of the output. Average revenue is expressed as follows :
Average Revenue = Total Revenue /Quantity sold
Symbolically, AR = TR / Q
Take the case of a single commodity we know that
TR = P × Q
So AR = P × Q / Q = P
Average revenue and price of the commodity are one and the same.
Marginal Revenue (MR) :
Marginal revenue is defined as increase in total revenue due to one unit increase in the sale of the quantity of the output. Marginal revenue is expressed as follows :
Marginal Revenue (MR) = Rate of change in total revenue / Rate of change in quantity of the commodity sold