1. INTRODUCTION
Cost is normally considered from the producer’s or
firm’s point of view. A firm has to employ an
aggregate of various factors of production such as
land, labour, capital and entrepreneurship.
2. The cost of production of a commodity is the
aggregate of price paid for the factors of production
used in producing that commodity. Cost of
production, therefore, denotes the value of the
factors of production employed.
3. The Cost of Production
Total revenue is the amount of a firm receives for
the sale of its output. Total cost is the market value
of the inputs a firm uses in production.
Profit = total revenue minus total cost.
4. “Real cost of production” refers to the physical
quantities of various factors used in producing a
commodity. Real cost, thus, signifies the aggregate
of real productive resources absorbed in the
production of a commodity (or a service).
5. The real cost of production signifies toils, troubles,
sacrifice on account of loss of consumption for
savings, social effects of pollution caused by factory
smoke, automobiles, etc.
6. Real Cost –
The real cost of production of a commodity refers to
the exertion of labour. Sacrifice involved in the
abstinence from present consumption by the savers
to supply capital and social effects of pollution
congestion, etc.
It’s an abstract idea. Its exact measurement is not
possible.
7. Opportunity Cost – The cost of something is what
you give up to get it.
The concept of opportunity cost is based on the
scarcity and versatility characteristics of productive
resources. It is the most fundamental concept in
Economics.
It is the cost measured in terms of forgone benefits
from the next best alternative use of a given
resource.
8. The concept of opportunity cost is based on the
scarcity and versatility (alternative applicabilities)
characteristics of productive resources. It is the
most fundamental concept in economics.
9. Wants are multiple. When we choose the resource in
one use to have one commodity for satisfying a
particular want, it is obvious that its other use as
some other commodity that can be produced by it
cannot be available simultaneously.
This means,the second alternative use of the
resources (or another commodity) is to be sacrificed to
have the resource employed in one particular way,
10. i.e. to get a particular commodity; because the same
resource cannot be employed in two ways at the
same time. The sacrifice or loss of alternative use of
a given resource is termed as “opportunity cost”.
11. Importance of the Concept of Opportunity Cost
1. Determination of Relative Prices of Goods:
The concept of opportunity cost is useful in
explaining the determination of relative prices of
different goods. For instance, if the same group of
factors can produce either one car or six scooters,
then the price of one car will tend to be at least six
times more than that of one scooter.
12. 2. Determination of Normal Remuneration to a
Factor: The opportunity cost sets the value of a
productive factor for its best alternative use. It
implies that if a productive factor is to be retained
in its next best alternative use, it must be
compensated for or paid at least what it can earn
from its next best alternative use.
13. 3.Decision-Making and Efficient Resource
Allocation:
The concept of opportunity cost is essential in rational
decision-making by the producer.
It follows that a resource will always tend to move or
will be used in an occupation where it has a high
opportunity cost. Thus, the concept of opportunity
cost serves as a useful economic tool in analyzing
optimum resource allocation and rational decision-
making.
14. Importance –
(1) Determination of Relative prices of goods.
(2) Determination of normal remuneration to
a factor.
(3) Decision making & efficient resource allocation.
Money Cost – Cost of production measured in terms
of money is called money cost. It is the monetary
expenditure on inputs of various kinds – raw
material, labour, etc.
15. Money Cost
“Money cost” is the monetary expenditure on inputs
of various kinds – raw materials, labour etc., required
for the output, i.e., the money spent on purchasing
the different units of factors of production needed for
producing a commodity. Money cost is, therefore, the
payment made for the factors in terms of money.
16. Explicit & Implicit Costs
Explicit cost are direct contractual monetary
payments incurred through market transaction.
Explicit costs refer to the actual money outlay of
the firm to buy or hire the productive resources.
17. It includes –
(1) Costs of raw material
(2) Wages & Salaries
(3) Power Charges
(4) Rent of business or factory premises
(5) Interest payment of capital invested
(6) Insurance premium
19. Implicit Costs
Implicit money costs are imputed payments which
are not directly or actually paid out by the firm. It
arises when the firm or entrepreneur supplies
certain factors owned by himself.
Implicit costs are as follows -
1) Wages of labour rendered by the entrepreneur
himself.
Contd..2……..
20. 2) Interest on capital supplied by him.
3) Rent of land and premises belonging to the
entrepreneur himself.
4) Normal returns of entrepreneur, a compensation
needed for his management and organisational
activity.
The distinction between explicit and implicit money
cost is important in analysing the concept of profit.
21. Fixed Cost –
Amount spent by the firm on fixed inputs in the short
run known as supplementary costs or overhead costs
it usually include –
1) Payments of rent for building
2) Interest paid on capital
3) Insurance premium
4) Depreciation and maintenance allowances
5) Administrative expenses – salaries
6) Property & business taxes, license fees, etc.
23. Variable Cost – (Prime Costs)
These costs are incurred by the firm as a result of
the use of variable factor inputs. They are dependent
upon the level of output.
It includes –
o Prices of raw materials
o Wages of Labour
o Fuel & Power charges
o Excise duties, sales tax
o Transport expenditure
24. The distinction between prime costs (variable costs)
and supplementary costs (fixed costs) is, however, not
always significant. In fact,the difference between fixed
and variable costs is meaningful and relevant only in
the short period. In the long run, all costs are
variable because all factors of production become
adjustable in the long run. In the short period, only
those costs are variable which are incurred on the
factors which are adjustable in the short period.
25. In the short run,however,the distinction between
prime and supplementary costs is very significant
because it influences the average cost behavior of the
product of the firm. Thus, it has a significant bearing
on the theory of firm. In specific terms, the
significance of making this distinction between fixed
and variable costs is that in the short period a firm
must cover at least its variable or prime costs if it is
to continue in production.
26. Even if a firm is closed down, it will have to incur
fixed or supplementary costs. The firm will suffer
no great loss in continuing production, if it can
cover at least its variable costs under the
prevailing price.
27. Types of Production Costs & their measurement
Total Cost – Aggregate of expenditures incurred by
the firm in producing a given level of output.
TC = TFC + TVC
TFC – It is the total cost of fixed factors of production
employed by the firm in the short run.
28. In economic analysis, the following types of costs
are considered in studying cost data of firm:
1. Total Cost (TC),
2. Total Fixed Cost (TFC),
3. Total Variable Cost (TVC),
4. Average Fixed Cost (AFC),
5. Average Variable Cost (AVC),
6. Average Total Cost (ATC), and
7. Marginal Cost (MC).
29. Total Fixed Cost (TFC)
Suppose a small furniture-shop proprietor starts his
business by hiring a shop at a monthly rent of
Rs.1,000, borrowing loan of Rs.10,000 from a bank at
an interest rate of 12%, and buys capital equipment
worth Rs.900. Then his monthly total fixed cost is
estimated to be:
Rs.1,000 + Rs.900 + Rs.100 = Rs.2,000.
(Rent) (Equipment Cost) (Monthly Interest
on the loan)
30. Definition: Total fixed cost is the total cost of
unchargeable,or fixed, factors of production
employed by the firm in the short run.
31. Again, TVC = f (Q) which means, total variable cost is
an increasing function of output.
Suppose,in our illustration of the furniture-shop
proprietor, if he was to start with the production of
chairs, he employs a carpenter on a piece-wage of
Rs.100 per chair. He buys wood worth Rs.2,000,
rexine-sheets worth Rs.3,000, spends Rs.500 for
other requirements to produce 5 chairs.
32. Then his total variable cost is measured as:
Rs.2,000(wood price)+Rs.3,000(rexine cost)+ Rs.500
(allied cost)+Rs.500 (labour charges)= Rs.6,000.
Definition: Total variable cost is the total costs of
variable factors employed by the firm at each level
of output.
33. TVC - TVC = F (Q)
It is the total cost of variable factors employed by
the firm at each level of output.
AFC – Total fixed cost divided by total units of output
(Q stands for the numbers of units of the product)
34. AVC-Total variable cost divided by total units of output
ATC – Total cost divided by total units of output
Marginal Cost (MC) -
It is the addition made to the total cost by producing
one more unit of output.
35. Long run costs :
Long run period is long enough to enable a firm to
vary all its factor inputs. In the long run a firm can
move from one plant capacity to another. Firm can
increase or decrease plant capacity according to
nature of demand.
37. MC
AC
M
A AC & MC
C RELATIONSHIP
O B
S
T
C
N
L Q
38. In the long run there is no dichotomy of total cost
into fixed and variable costs as in the short run.
Long run involves various short run adjustments
visualized over a period of time.
Long run average cost curve is the envelope of the
various short run AC curves.
39. Y SAC3 LAC
SAC1 SAC2
C OUTPUT
O
S
T
X
O Q1 Q2 Q3
• LAC is the Locus of all these points of tangency.
• LAC is enveloping to a number of plant sizes and the related
sizes.
• It is regarded as the long run planning device. A rational
entrepreneur would select the optimum scale of plant.
• It is flatter U shaped means in the beginning it slopes down
gradually after a certain point it begins to slope upward.
40. Cost Leadership
Introduced By Michel Porter towards Competitive
Advantage
Lowest cost of peration in the business by the firm
Business Strategy of doing the business at the owest
possible cost in a market
AVIATION INDUSTRY MALAYSIA-Air Asia-Lowest
COST –Largest profit
41. How to achieve cost leadership?
Cost Control measures
Avoiding wastage ‘better supervision on the workers
Access to cheaper source of capital and required finance
Focus on quantitative targets for the business expansion
ensuring that the cost is maintained at the minimum
level
42. Contd ..
Wall Mart has earned cost leadership reputation in
retail trade
Modern business follows two generic evel stretegies
Product differentiation
Cost leadership
43. Sources of cost leadership
Economics of scale
Reaching to a level of minimum efficient scale much
earlier than the competing firms in the market
Learning curve effect.
Inter nationalization.
Technological acquisition and improvement.
Access to low cost inputs.
Knowledge management.
44. Competitive threats by a firm
Threat of new entry
Threat of rivalry
Threat of substitutes
Threat of suppliers
Threat of buyers
