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Cost

1) The document discusses different types of costs including future and past costs, incremental and sunk costs, out-of-pocket and book costs, replacement and historical costs, explicit and implicit costs, and actual and opportunity costs. 2) It also discusses total cost, average cost, and marginal cost, and how the shape of the long-run average cost curve is determined by economies and diseconomies of scale. 3) Economies of scale can be internal from plant expansion or external from industry growth, while diseconomies of scale internally arise from managerial or labor inefficiencies from increased production.

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Saurabh
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107 views14 pages

Cost

1) The document discusses different types of costs including future and past costs, incremental and sunk costs, out-of-pocket and book costs, replacement and historical costs, explicit and implicit costs, and actual and opportunity costs. 2) It also discusses total cost, average cost, and marginal cost, and how the shape of the long-run average cost curve is determined by economies and diseconomies of scale. 3) Economies of scale can be internal from plant expansion or external from industry growth, while diseconomies of scale internally arise from managerial or labor inefficiencies from increased production.

Uploaded by

Saurabh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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THEORY OF COST:

CONCEPTS OF COSTS-
1) Future and past costs-Future costs are expected
to be incurred in the future periods. Past costs
are actual costs incurred in the past and they
are always contained in the income statements.
2) Incremental and Sunk costs: Incremental costs
are defined as the change in overall costs that
result from particular decision being made. In
the short period, incremental cost will consist of
variable cost-costs of additional labour,
additional raw materials, power, fuel etc., which
is the result of a new decision being taken by
the firm.Since these costs can be avoided by not
bringing about any change in the activity, the
incremental costs are also called avoidable or
escapable costs.
SUNK COST- Sunk cost is not affected or
altered by a change in the level or nature of
business activity.It will remain the same
whatever the level of activity. Example is
depreciation. Sunk costs are irrelevant for
decision making.
3) Out-of Pocket and Book Costs-Out of
pocket costs are those that involve immediate
payments to outsiders as opposed to book
costs that do not require current cash
expenditure.
The wages and salaries paid to the employees
are out- of -pocket costs while salary of the
owner manager if not paid , is a book cost.
Thus the difference between these two
categories of cost is in terms of whether the
company owns it or not. If a factor of
production is owned, its cost is a book cost
while if it is hire it is an out-of-pocket cost.
4) REPLACEMENT AND HISTORICAL COSTS –
Historical cost of an asset states the cost of
plant, equipment and materials at the price
paid originally for them, while the
replacement cost states the cost that the firm
would have to incur if it wants to replace or
acquire the same.
5) EXPLICIT COSTS AND IMPLICIT OR IMPUTED
COSTS- Explicit costs are those expenses,
which are actually paid by the firm (paid-out-
costs). These costs appear in the accounting
records of the firm. On the other hand ,
implicit costs are theoretical costs in the
sense that they go unrecognized by the
accounting system. These costs may be
defined as the earnings of those employed
resources which belong to the owner himself.
ACTUAL COSTS AND OPPORTUNITY COSTS:
Actual costs mean the actual expenditure
incurred for acquiring or producing a good or
service. These costs are the costs that are
generally recorded in book of account , for
example, actual wages paid, cost of raw
materials purchased, interest paid etc. These
costs are also commonly called Absolute
costs or outlay costs.
OPPORTUNITY COSTS –The concept of
opportunity occupies a very important place
in modern economic analysis. The
opportunity costs or alternative costs are the
return from the second use of the firm’s
resources, which the firm forgoes in order to
avail itself of the return from the best use of
resources.
SHUT-DOWN AND ABANDONEMENT COSTS:
Shut-down costs are required to be incurred
when the production operations are
suspended and will not be necessary, if the
production operations continue. For example,
if the production is suspended, the plant,
machinery or equipment will have to be
protected by putting up sheds, using
tarpauline, plastic sheets etc. Such costs are
called shut-down costs.
When any plant is to be permanently closed
down, some costs are to be incurred for
disposing of the fixed asset. These costs are
called abandonment costs.
TOTAL COST, AVERAGE COST AND MARGINAL
COST:
TOTAL COSTS: It includes all cash payments
made to hired factors of production and all
cash charges imputed for the use of owner’s
factors of production in acquiring or
producing a good or service. Thus total cost
of a firm is the sum of the explicit plus
implicit expenditures incurred for producing
a given level of output.
AVERAGE COST: It is the cost per unit of output
assuming that production of each unit of
output incurs the same cost.
MARGINAL COST: It is the extra cost of
producing one extra unit.
SHAPE OF LAC- The shape of LAC is
determined by economies and diseconomies
of scale. In fact the factors which determine
the shape of the LAC or cause the operation
of the laws of returns to scale are grouped
under economies and diseconomies of
scale.Increasing returns to scale operates
when economies of scale are greater than
diseconomies of scale, and returns to scale
decrease when diseconomies of scale are
greater than the economies of scale.
ECONOMIES OF SCALE: It can be classified under two
groups:
1. Internal or real economies.
2. External or pecuniary economies.
Internal economies are those which arise from the
expansion of plant size of the firm.The
economies are internal in the sense that
economies are internationalized to the expanding
firms and not available to non-expanding
firms.Internal economies can be classified under
the following categories- a) economies of
production b) economies of marketing c)
Managerial Economies d) Economies in transport
and storage,
Diseconomies of scale-These are the
disadvantages that arise due to the expansion
of production of scale and leads to rise in the
cost of production. Diseconomies can be of
two types-a) internal b) external
The causes of internal diseconomies are a)
Managerial inefficiency b) Labour inefficiency

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