; Cost Concepts
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Cost Concepts


  • pg 1
									Managerial Economics

   3.Cost Function
   Cost Concepts
    A Sanjeev raj
     Today we are going to deal with..

• Cost Concepts.
• There are various prevalent cost concepts.
• Cost is understood differently for different purposes.
• Cost may include price to be paid for a good, its
  transportation, storage and handling expenses besides
  other miscellaneous outflows.
• A Cost which may be relevant for one particular type of
  decision is very likely to be meaningless for arriving at
  some other decision.
•   Relevant Cost.
•   Actual Cost.
•   Opportunity Cost.
•   Fixed Cost.
•   Variable Cost.
•   Explicit Cost.
•   Implicit Cost.
•   Total Cost.
•   Average Cost.
•   Marginal Cost.
•   Historical Cost.
•   Replacement Cost.
•   Short – run Cost.
•   Long – run Cost.
•   Accounting Cost.
•   Economic Cost.
                Relevant Cost
• It is defined as the cost that actually affects a given
  business decision and should therefore considered in the
  decision – making process.
Actual Cost:
  Costs that are actually incurred in acquiring or producing
  a good or service are known as actual costs. Since these
  costs are real cash outflows and are generally recorded
  in account books, they are also called acquisition or
  accounting cost.

  E.g., Rent, Wages, etc.
                 Opportunity Costs

• It is the notional cost of sacrificing the alternatives.

• E.g., Consider a firm that has Rs.100. With this amount it
  can either make a fixed deposit with a bank and earn an
  interest of 10% p.a or purchase the factors of production
  for producing t – shirts. Let the cost of land, labor capital
  and management be Rs. 20, 35, 30, 10, respectively.

• It is not recorded in the books of account.
Fixed Cost

• They are defined as the cost that remain constant with
  respect to the output.
• They might exist even if no output is produced.
Variable Cost:
  Costs that vary with the changes in the output are known
  as variable costs.
  E.g., Costs of raw material, Wages
Semi Variable Cost: There are some costs which cannot
  be so easily distinguished into fixed or variable costs.
E.g., Charges for Electricity, Incentive based salary
Explicit Costs:
- They are out of pocket costs for which a cash payment is
- The Payment for raw material, utilities, wages, etc.
  constitutes of explicit costs.
Implicit Costs:
- Costs that don’t involve a cash outlay.
- Also called as Book costs.
- Depreciation and salary of owner, etc.
- Since implicit costs do not involve cash payment, they are
  often ignored by firms, especially smaller ones.
• If a building is owned by a firm, then the rent that would
  have been received had it been rented would become
  the implicit costs.
• However , if the building was taken on rent by the firm,
  then the rent would be an explicit cost.
Total Cost:
- The sum total of all the costs: fixed, variable, explicit and
  implicit for the entire output is known as total cost.

Average Cost:
- It is the cost per unit of output and is computed by
  dividing the total cost by the number of units produced.

Marginal Costs:
- It is the change in total costs due to the production of
  one additional unit of output.

• Let the cost of producing 10 units be Rs. 5000 and that
  for 11 units be Rs. 5050.
• In this case, the average cost of each unit is Rs. 500 and
  the Marginal Cost of producing the eleventh unit is Rs.
            Incremental Cost

• It is the change in total cost due to the
  production of additional output.
Historical Cost:
- It is a past cost that was actually incurred at the time of
  acquisition of that asset.

Replacement Cost:
- It is the current cost of purchasing that asset now.
  Depending upon the nature of the commodity or asset,
  the replacement cost will be more than or less than the
  historical cost.
- A machine costing Rs. 2 lakh was purchased 5 years
  ago. Over time it has depreciated at the rate of 10% per
  annum. It is presently worth Rs. 1.18 lakh. Here, Rs. 2
  lakh is the historical cost & 1.18 lakh Rs. is its
  replacement cost.
Short – run costs:
- It is the cost that varies with output when plant and
  equipment remain the same.

Long – run costs:
- It is the cost that varies with output when all the factor
  inputs change.
Accounting Costs:
- Costs that are recorded in the books of account and are
  used for accounting, auditing and financial control and
  are known as accounting costs.

Economic Costs:
- Costs that help in managerial decision making for
  achieving the economic objectives of the firm are called
  economic costs.
Thank You

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