Kinds of cost

There are different kinds of Costs.

1. Actual Cost/Acquisition cost/Outlay Cost.

2. Opportunity cost.

3. Sunk Cost

4. Explicit cost/Paid up cost.

5. Implicit / Imputed cost.

6. Incremental /Avoidable/Escapable/Differential cost.

7. Book Cost.

8. Out-of-pocket cost.

9. Accounting cost.

10. Economic Cost.

11. Private cost.

12 . Social cost.

13 Direct Cost.

14 Indirect Cost.

13. Controllable cost.

14. Non-Controllable cost.

15. Replacement cost.

16 . Original/Historical cost.

17. Shutdown cost.

18. Abandonment cost.

19. Urgent cost

20. Postponable cost.

21. Business Cost.

22. Full cost.

23. Marginal cost.

24. Average cost.

25. Total cost.

Actual Cost:- These are the cost which the firm incurs while producing or acquiring a good or a
service. Ex Cost of raw material, labour, rent, interest etc,

Opportunity cost:-These are the return from the best use of the firm’s resources which the firm
forgoes in order to avail of the return from the best use of the resources.

Sunk cost:- These are the cost that are not altered by change in quantity or cannot be recovered.
E.g. Depreciation

Explicit Cost:- Are those expenses which are actually paid by the firm. E.g. Interest paid on borrowed
capital.

Implicit Cost:- Are theoretical cost ,they go unrecognized by the accounting system.E.g amount of
interest earned by the owner.

Incremental Cost:- Are the additional cost resulting from a change in the nature & level of business
activity. E.g. Change in product line or output level etc.

Book Cost:-Are those business cost which do not involve any cash payments but provision is made
for them in the books of accounts. E.g. depreciation.

Out-of-pocket Cost:-Are those expenses which are current cash payments to outsiders.

Accounting Cost:-Are the actual or outlay cost. These cost point out how mush expenditure has
already incurred on a particular process or on production.

Economic Cost:- These are the cost which relate to future.

Private Cost:- Are those cost which are actually incurred or provided for its business activity.

Social Cost:-These are the cost which are related to the activity of the business which will affect the
society. E.g. Greater pollution, leakages etc.

Direct Cost:-Are the cost that have direct relationship with a unit or operation.

Indirect Cost:- Are those cost whose course cannot be easily & definitely traced .

Controllable Cost:- Are those cost which are capable of being controlled or regulated by vigilance.

Non-Controllable Cost:- These are the cost where after vigilance also , cannot be controlled.

Replacement Cost:- The cost that the firm would have to incur if it wants to replace or acquire the
same asset.

Original Cost:-The cost of plant, equipment & materials at the price paid originally for them.

Shutdown Cost:- Are those which firm incurs if it temporarily stops it operations.
Abandonment Cost:- Are the cost of retiring altogether a fixed asset from use.

Urgent Cost:-Are those that must be incurred so that the operation of the firm continue.

Postponable Cost:-These are the cost whose postponement does not affect the operation efficiency
of the firm.

Business Cost:- Are relevant for the firm’s profit & loss accounts & for legal and tax purpose.

Full Cost:- Are the sum of opportunity cost and normal cost.

Marginal Cost:- Are the incremental or additional cost incurred when there is addition to the existing
output of goods or services.

Total Cost:- These cost represents the money value of the total resources required for production of
goods & services by the firm.

Average Cost:- Is the cost per unit of output, assuming that production of each unit of output incurs
the same cost.
Production is an activity that transforms inputs into output”. Production involves producing, storing
& distributing goods and services. For ex garment mills uses labour, raw materials, machinery,
buildings & capital to produce dress materials, a change in space (ex rail transportation), change in
time (ex cold storage). Production is thus an activity that increases consumers usability of goods.

Factors of Production

The following are the factors of production without which the process of production will not takes
place.

1) Land,

2) Labour,

3) Capital,

4) Organization,

5) Knowledge,

6) Technology.

Technology

It is an another important factor of production. A firms production behavior is

fundamentally based by the state of technology. Upgraded technology sets upper limit for
the production of the firm, irrespective of the nature of output, size of the firm & the
knowledge of the management.

The production function is purely a technology relationship which express the relation between
output of a good & different combinations of inputs used in its production.

The production function is written mathematically as

Q = F [ L, N,K,…….]

Q= Amount of output,

L= Land,

N= Labour,

K= Capital.

Production function is based upon two assumptions

i. Technology is invariant,

ii. It is assumed that firms utilize their inputs at maximum level of efficiency.

Law of Variable Proportion

This law states that “As more of one factor input is employed, all other input quantities held
constant, a point will eventually be reached where additional quantities of the varying input will
yield diminishing marginal contributions to total product.”

MP= ΔTP AP= TP

ΔL L

MP= Marginal Product.

AP= Average Product.

TP= Total Product.

Economies of Scale

There are two kinds of economies of scale.

1. Internal Economies of scale.

2. External Economies of scale.

Internal Economies of scale:- Are those which arise from the firm increasing its plant size. These
relate only to the long run & determine the shape of the long run cost curve.

External Economies of scale:- Are those which arise outside the firm ; from improvement or
deterioration in the environment in which the firm operates. The external economies to the firm
may be realized from actions of other firms in the same or in another industry.

Internal Economies of scale:- These are categorized into 2 types of economies.

1) Real Economies:- These arise when the quantity of inputs used for a given level of output
decreases.

2) Pecuniary Economies:- Are those savings in expenses, which accrue to the firm in the nature
of relatively lower price paid for inputs & lower costs of production.

Real Economies of scale:- There are 4 kind of real economies.

1. Production Economies,

2. Marketing Economies,

3. Managerial Economies,

4. Transport & Storage Economies.

Pecuniary Economies:- Includes the following

I. Lower raw material price due to bulk buying,

II. Lower cost of capital because of lower rate of interest charged for large firms,

III. Offers lower rates for advertising to large firms because of large scale advertising,

IV. Lower transportation rates due to bulk transportation,

V. Lower wages & salaries due to monopsonistic power & prestige associated with large firms.

External Economies of Scale

External economies help in cutting the cost in following ways,

1. By Expansion, certain specialized firms come up for working up the by-products and waste
materials.
 2. Specialized firms come up for supplying raw materials, tools etc to the firms in the industry
at very lower price.

3. They can combine together to undertake the work, or research which will be benefited to all
the firms in the industry.

Diseconomies of Scale

When a firm expands a level, it encounters growing diseconomies. A stage will come when
diminishing returns starts, when a firm continues to expand its size beyond its level. These rise in
average cost of production, decrease in overall profitability of the company.

1. Technical factors are more likely to ‘limit’ the sources of economies of scale & then act as a
source of diseconomies.

2. Diseconomies of scale arise more likely to be associated with human & behavior problems of
managing a large enterprise.

3. Due to lack of personal touch, the spirit in a large firms is less. This leads to the problems of
morale & motivation of both management & labour force.