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156, , , , 9.1 Introduction, , 9.2 Cost Concepts, A.~ Money Cost - Implicit and Explicit, B. Accounting Cost and Economic Cost, C. Fixed, Variable and Total Cost, D._ Total, Average and Marginal Cost, , , , , , imisi i onitor continuously about its cost and, sn Tian somes ee revenue that determines the overall, Tevenur: Ee vs _ es firm. In order to maximise profits a firm has to increase, De a Ic er its cost. The level of revenue to a large extent is, ws ae and he i fate factors and, therefore the firm’s ability to, Ss oman is limited. On the other hand, the.cost can be brought, influence the sy produce the optimum level of output using the least cost, aoe norm wd at ion or by increasing productivities of inputs, or by, ri ae comin sandactioral efficiency. Thus the cost of production is the, ae ne fe tor which determines the supply of a product. It is the, ani el he basis for many managerial decisions like which price to, Cost that ae t ‘increase the production, etc. However it should be noted, ee went relevant for every decision under consideration., , hat a, , , , , , the, cof

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ce, , x F, , Cost Concepts . 157, , Production and cost analysis are concerne, market. Production anal, is done in money terms., , : d with the supply side e the, lysis is done in physical terms while cost analysis, In this chapter we present an analysis of cost., , , , There are various concepts of cost. A firm may use different Ranceprs, depending upon a particular situation and the type of business decision 8,, be made. An understanding of these concepts will be helpful to the firm., , A. Money Cost - Implicit and Explicit, . ), , Implicit costs (IC) are due to the factors which the entrepreneur himself, owns and employs in the firm. In other words they are the imputed value, of the entrepreneurs’ own resources and services. The wage or salary for, the services of the entrepreneur, interest on the money capital invested by, him and the money rewards for other factors owned and used by him in, the firm are known as implicit costs. If these services or factors are sold, elsewhere by the entrepreneur he would have earned an income. Thus,, implicit costs are the opportunity costs of the factors owned and used by, the entrepreneur. Since direct cash payments are not made for them, these, costs are called implicit costs. Implicit cost is also called indirect cost., , IC = Imputed cost of resources owned by the entrepreneur, , = Opportunity cost of resources owned by the entrepreneur, = Indirect Cost, , = Implicit Cost, , Explicit costs (EC) are the contractual cash payments made by the firm, for purchasing or hiring the various factors. In other words, explicit costs, efer to the actual expenditures of the firm to hire, rent, or purchase the, inputs it requires in production. They include wages and salaries, payments, for raw materials, power, light, fuel, advertisements, transportation and, taxes. Explicit money cost is the accounting cost, because an accountant, takes into account only the payments and charges made by the firm to the, suppliers of various productive factors. Explicit cost also refer to out-ofPocket cost or direct cost., , EC = Expenditure on hiring or purchasing inputs, , Out of pocket cost = Direct cost

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158 Business Economics - | (BMS, BAF, BFM, BBL: SEM.), , B. Accounting Cost and Economic Cost, , Accounting cost refers only to the firm's actual expenditures or expligi, costs. Accounting costs are important for financial reporting by the firm, and for tax purposes. However, for managerial decision-making PUTPose,, economic cost is the relevant cost concept., , An economist would include both explicit and implicit costs in the cost o, production. Therefore, economic costs equal to explicit costs plus implic, costs. Thus, we can make a distinction between economic cost ang, accounting cost., , This distinction between explicit and implicit costs is important ip, analysing the concept of profit. From the economist’s point of view profi, is the difference between total revenue and economic costs. On the othe,, hand, accounting profit, that is, accountant’s concept of profit, is the, difference between total revenue and accounting costs., , Accounting Cost = Explicit Cost, Economic Cost = Implicit + Explicit Cost, Accounting Profit = Total Revenue - Explicit Cost (Accounting Cost), , Economic Profit = Total Revenue - Total Cost (Implicit + Explicit Cost), , C. Fixed, Variable and Total Cost., , , , Fixed Cost, , , , Total cost of production consists of fixed cost and variable cost., , Fixed costs are those which are independent of output. They must be paid |, even if the firm produces no output. They will not change even if output, changes. They remain fixed whether output is large or small. Fixed costs, are also called “overhead costs” or “supplementary costs”. They include |, such payments as rent, interest, insurance, depreciation charges, maintenance costs, property taxes, administrative expense like manager 5, salary and so on, In the short period, the total amount of these fixed costs, will not increase or decrease when the volume of the firms output rises 0!, falls (See Table 9.1)., , Fixed Cost = Overhead Cost = Supplementary Cost

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Cost Concepts fee, Variable Cost, , Variable cost are those which are incurred on the employment of yauineis, factors of production. They vary with the level of output. They sae far, with the rise in output and decrease with the fall in output. By de eee, variable costs remain zero when output is zero. They include EN ied, wages, raw materials, fuel, power, transport and the like. Marshall calle, these variable costs as “Prime Costs” of production., , The relation between total variable cost and output may not be Enea, fiat, is, variable cost may not increase by the same amount for every unit ine, in output., , Variable Cost = Prime Cost, Total Cost, , The total cost (TC) of the firm is a function of output (q)- It will ta, with the increase in output, that is, it varies directly with the output., symbols, it can be written as, , TC =f (q), , Since the output is produced by fixed and variable factors, the total cost, can be divided into two components : total fixed cost (TFC) and total, variable cost (IVC)., , TC =TFC + TVC, , Table 9.1: A Schedule of a Firm's Fixed,, Variable and Total Cost, , , , , , All Cost in Rupees, Output Total Fixed Total Variable Total, , (Q) Cost (TFC) Cost (TVC) Cost (TC), (1) (2) : (3). (4), , 0 100 0 100, , 1 100 25 125, , 2 100 40 140, , 3 100 50 150, , 4 100 70 170, , 5 100 100 200, , 6 100 “145 245

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160, , Business Economics - I (BMS, BAF, BFM, BBI.: SEM.) |, , , , , , 7 100 205 305, 8 * 100 ‘ 285 385, 9 100 385 485., 10 100 515 615, , , , , , , , , , Table 9.1 shows a simplified cost schedule showing the relation betwee,, costs for each different levels output. We can observe the following relations, , 1:, 2., 3;, , Production (output) is shown in column 1., The column (2) shows that TFC remains fixed at all levels output., , The column (3) shows that TVC varies with the output and it is zero, when the output is nil. It can also be observed from the column (3), that TVC does not change in the same proportion. In the beginning as, the output increases, TVC increases at a decreasing rate, but after a, point it increases at an increasing rate. This is due to the operation of, the law of variable proportions., , The column (4) shows that total costs are equal to fixed plus variable, , costs. TC varies with the change in output in the same proportion as, the TVC., , The above costs and output relations are also shown in Figure 9.1. By, plotting the cost data of Table 9.1 graphically and joining the plotted points, by smooth curves, we can obtain total fixed, total variable, and total cost, curves. 5, , + TC, , TVC, , Total Cost, , TFC, , , , , , ep >X, Output, , Fig. 9.1 : Total Cost Curves, , , , ww Bw, , wee