Cost Analysis: Types of Cost

Meaning and types of cost

Cost of production refers to the total monetary expenses incurred on various inputs, employed in the production of the commodity or we can say that it refers to the total money expenses incurred by the firm in the process of transforming inputs into outputs.

Types of Costs: The types of costs are as follows:

Money cost and Real Cost: Money cost relates to all the expenditures which are made in the terms of money such as cost of raw materials, wages of the labors, payment of rent, Interest on capital, expenses on fuel, power, transportation, and many other production-related costs. It is also called the nominal cost or expenses of production.

The real cost is expressed in terms of the efforts, exertions, discomforts, sacrifices, and inconveniences bear by all factor owners in the production of the commodity. Adam Smith regarded pains and sacrifices of labor as a real cost. Marshall called it the social cost.

Explicit costs and Implicit costs: Explicit costs are paid out costs. The payment for wages and salaries, prices of the raw materials, insurance premium, depreciation charges, are the example of explicit cost. These costs involve cash payment, which can be estimated, calculated exactly, and recorded in the account books.

Implicit costs are implied costs. There are certain other costs that don’t take the form of cost outlays and don’t appear in the accounting system. Thus, implicit costs are the cost of self-owned and self-employed resources such as rent of own land or return on the entrepreneur’s own investment.

The total cost is a sum of both explicit and implicit costs. 

Actual cost and opportunity cost: Actual cost is also called outlay cost, absolute cost, and acquisition cost. Actual cost are those cost which are incurred by the firm in the payment for the labor, material, plant, building, machinery, transport, advertising, etc. and are recorded in the books of accounts.

Opportunity cost may be defined as the expected returns from the second-best use of the resources which are foregone due to the scarcity of resources. In other words, it is the cost of missed opportunities or cost of sacrificed alternatives.

Direct Costs and Indirect Costs: Those costs which can be specifically assigned to a particular product, a department, or a process of production and are traceable, are considered direct costs, such as, expenses on raw materials, fuel, wages of labor, salary to a divisional manager, etc.

Indirect costs are those costs that are not traceable to any one unit of operation and can not be attributed to a product, or a department, such as expenses incurred on the electricity bill, water bill, other administrative expenses, etc.

Business Costs and Full Costs: Business Costs include all the costs which are incurred in executing the operations of the business. It includes all the payments and contractual obligations made by the firm together with the book cost of depreciation on plant and equipment. It is helpful for calculating business profit and loss.

Full Costs are the total cost incurred in production and include business cost, opportunity cost, and normal profit. opportunity cost is the cost of missed opportunities or the cost of sacrificed alternatives. The normal profit is the minimum earning that the firm must earn in addition to the opportunity cost to remain in its present occupation.

Fixed Costs and Variable Costs: Fixed Costs are those costs that remain constant for a certain given output such as the depreciation of machinery, building, and other fixed assets, etc.

Variable Costs vary with the variation in the total output or change with the number of units produced. It includes the cost of raw material, running cost of fixed capital, wages of labor, salaries of a manager, and the cost of other factors that vary with output.

Total, Average and Marginal Costs: Total cost is the sum of total fixed cost end total variable cost. It refers to the total expenditure incurred on the production of goods and services.

The average cost per unit is the total cost divided by the number of units produced. It is the sum of the average fixed cost and the average variable cost.

Marginal cost is the change in total cost resulting from the unit change in the quantity produced. It is the addition to the total cost caused by producing one additional unit of the product.

Short-run and Long-run Costs: Short run costs vary with the variation in output. In other words, variable costs are called short-run costs.

Long-run costs are related to fixed costs. The costs which are incurred on the fixed assets like plant, building, and machinery, etc. In the long run, the fixed cost also becomes variable costs because of the increase in the scale of production.

Thus, the short-run costs are associated with variables in the utilization of fixed plant whereas long-run costs are associated with the change in the size of the plant.

Incremental costs and Sunk Costs: Incremental costs represent the change in cost due to a change in the level or nature of the business activity. For example, if the firm decides to set up the marketing and sales division in another city, then it is considered an incremental cost.

The cost that has already incurred and cannot be altered, increased or decreased are called as the sunk costs.

Historical Costs and replacement Costs: Historical costs are those costs, incurred in the previous periods and are used for accounting purposes to know about the net worth of the firm.

Replacement costs refer to the outlay which is required for replacing an old asset and it is important in making business decisions regarding the renovation of the firm.

Private Costs and Social Costs: Private costs are incurred by an individual or a firm on the purchase of goods and services from the market.

Social costs refer to the total cost borne by society due to the production of a commodity. It includes both private costs and the external costs.

Dr. Swati Gupta

Want to understand the concepts of Economics in a simple and better way? 

Please visit my YouTube channel Learn Economics by Dr. Swati Gupta to view videos on multiple topics of Economics.

Please click on the image below to subscribe to this channel.