THE THEORY

AND
ESTIMATION OF
COST
MEMBERS:
AQUE, UDTUJAN, DAGSAN,
LADAO, ROMERO, ROSAURO
OBJECTIVES
1. Identify what is cost, its
function and its nature.

2.Distinguish between economic

cost and accounting cost

3. Explain how the concept of

relevant cost is used then
differentiate implicit costs and
explicit costs.

4. Understand total, variable,

average and fixed cost, short-
run cost functions, and long-run
cost curves.
What is cost?

• A cost is an expenditure required to produce or sell a product or get an

asset ready for normal use. In other words, it’s the amount paid to
manufacture a product, purchase inventory, sell merchandise, or get
equipment ready to use in a business process.
NATURE OF COST

• 1.Costs are incurred as a result of production.

• 2. Economists define cost in terms of opportunities that are sacrificed when a choice is made.
Therefore, economic costs are simply benefits lost .
• 3. Accountants define cost in terms of resources consumed. Accounting costs reflect changes in
stocks (reductions in good things, increases in bad things) over a fixed period of time.
• 1. Explicit costs - are actual expenditures of the firm to hire, rent, or purchase the inputs
it requires in production. These include the wages to hire labor, the rental price of
capital, equipment, and buildings, and the purchase price of raw materials and semi
finished products.
• 2. Implicit costs - refers to the value of the inputs that are owned and used by the firm in
its own production activity. These includes the highest salary that the entrepreneur could
earn in his or her best alternative employment and the highest return that the firm could
receive from investing its capital in the most rewarding alternative use for renting its land
and buildings to the highest bidder.
• Economic cost - refers to the sum of explicit and implicit costs. These costs must be
distinguished from accounting costs, which refer only to the firm’s actual expenditures, or
explicit cost, incurred for purchased or hired inputs.

• Alternative or Opportunity Costs - The cost to the firm of using a purchased or owned input
is equal to what the input could earn in its best alternative use. The firm must include the
alternative or opportunity costs because the firm cannot retain a hired input if it pays a
lower price for the input than another firm.
• 1. Relevant Costs: The costs that should be considered in making a
managerial decision; economic or opportunity costs.
• 2. Incremental costs: the total increase in costs for implementing a
particular managerial decision.
• 3. Irrelevant or Sunk Costs: The cost that are not affected by a
particular managerial decision.
Short-Run Cost Functions

• 1. In short-run period, some of the firm’s inputs are fixed and some
are variable, and this leads to fixed and variable costs.

• 2. Total costs is the cost of all the productive resources used by the
firm. It can be divided into two separate costs in the short run.
• Total Fixed Costs: The total obligations of the firm per time period for all the
fixed inputs the firm uses.

• Total Variable Costs: The total obligations of the firm per time period for all
the variable inputs the firm uses.
WRAP UP!!!

Accounting costs represent anything your business has paid for. You can
calculate accounting cost by subtracting your expenses from your revenue.
Economic costs represent any “what-if” scenarios for your business. You can
calculate economic cost by subtracting implicit costs from your accounting
cost.