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Home Cost Analysis Concept of Economic Costs

 

Concept of Economic Costs:

 

We have discussed the important types of cost which a firm has to face. The cost of production from the point of view of an individual firm is split up into the following parts. 

                   

(1) Explicit Cost:

 

Explicit cost is also called money cost or accounting cost. Explicit cost represents all such expenditure which are incurred by an entrepreneur to pay for the hired services of factors of production and in buying goods and services directly. In other words, we can say that they are the expenses which the business manager must take into account of because they must actually be paid by the firm.

 

Example:

 

The explicit cost includes wages and salary payments, expenses on the purchase of raw material, light, fuel, advertisements, transportation, taxes and depreciation charges.

                       

(2) Implicit Cost:

 

The implicit costs are the imputed value of the entrepreneur's own resources and services. Implicit costs can be defined as:

 

"Expenses that an entrepreneur does not have to pay out of his own pocket but are costs to the firm because they represent an opportunity cost".

 

Example:

 

For instance, if a person is working as a manager in his own firm or has invested his own capital or has built the factory at his own land, the reward of all these factors of production at least equal to their transfer prices is, included in the expenses of a business.

 

Implicit costs, thus, are the alternative costs of the self-owned and self-employed resources of a firm. The total costs of a business enterprise is the sum total of explicit and implicit costs. If the implicit costs are not included in the firm's total cost, the cost of the firm will be understated and it will result in serious error.

                                   

(3) Real Cost:

 

Real costs are the pains and inconveniences experienced by labor to produce a commodity. These costs are not taken in the costing of a commodity by the firm. Real cost has been defined differently by different economists.

 

Classical economists understood by real costs the pains and sacrifices of labor. Alfred Marshall calls real cost as social cost and describes it:

 

"Real costs of efforts of various qualities and real costs of waiting".

 

The Austrian School of Economists have criticized the meaning given to real cost by the classical economists and new classical economists. They say that to give a subjective value to cost is a hopeless task as when real cost is expressed in terms of sacrifices or pains, it is not amenable to precise measurement and thus it fails to explain the phenomenon of prices.

 

(4) Opportunity Cost:

 

The concept of opportunity cost has a very important place in economic analysis. It is defined as:

 

"The value of a resource in its next best use. It is the amount of income or yield that could have been earned by investing in the next best alternative".

 

Example:

 

The opportunity cost of a good can be given a money value. For instance, a labor is working in a factory and is getting $2000 P.M. The entrepreneur is paying him this amount because he can earn this amount in the next best alternative employment. If he pays less than this amount, he will move to next best alternative occupation, where he can get $2000 P.M.

 

So in order to obtain a productive service say labor in the present occupation, the cost should be equal to the amount which he can get in some alternative occupation. Similarly, a piece of land or capital must be paid as much as they could earn in their next best alternative use. The total alternative earnings of the various factors employed in the production of a good constitute the opportunity cost of a good. In a money economy, opportunity or transfer cost is defined as the amount of money which a firm must make to resource suppliers m order to attract these resources away from alternative lines of production. In the words of Lipsay:

 

"The opportunity cost of using any factor is what is currently foregone by using it".

 

The idea of opportunity cost has an important bearing on the decisions involving scarcity of resources, their alternative uses and the choice.

Relevant Articles:

Concept of Cost of Production
Concepts of Economic Costs

Analysis of Short Run Cost of Production

Average Cost
Short Run and Long Run Average Cost Curves
Marginal Cost
Relation of Average Variable Cost and Average Total Cost to Marginal Cost
 

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
Theory of Factor Pricing OR Theory of Distribution
Rent
Wages
Interest
Profits
Principles and Theories of Macro Economics
National Income and Its Measurement
Principles of Public Finance
Public Revenue and Taxation
National Debt and Income Determination
Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance

History of Money
 

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