COST ANALYSIS UNIT -3

Money spent on the production of a commodity

constitutes its cost of production
Cost Function - C = f (q ) , Cost function is a derived
function derived from production function.
Importance of cost concepts
Locating the weak points in production management
Minimizing the costs
Finding the optimum level of output
Determining price and dealers, margin
Estimating or projecting the cost of business
operation


COST CONCEPTS
1. Opportunity cost and actual cost -
Opportunity cost is the cost of the opportunity
lost. It is the income which could have been earned
if the scarce resources were used in the next best
alternative
Also called Alternative cost
Actual costs mean the expenditure incurred for
acquiring or producing a good or a service
They are recorded in the book of accounts
Also called as Outlay or Absolute cost



2. Actual or Explicit costs and Implicit or Imputed costs
Actual costs are those which are actually incurred
by the firm in payment for labour, material, plant,
building, machinery etc
They enter the book of accounts
Implicit costs are those costs which actually do not
take the form of cash outlays, nor do they appear in
the accounting system



3. Out of pocket and book costs
Out -of -cost are those that involve immediate
payment to outsiders
Book costs that do not require current cash
expenditure
4. Replacement and Historical Costs
Historical cost refers to the cost incurred in the past
on the aquisition of productive assets
Replacement costs refer to the outlay that has to
be made for replacing an old asset
Instability in prices make the two differ from each
other




5. Private and Social costs
The costs which are related to the working of the
firm and are used in the cost benefit analysis of
business decisions are called private costs
Social costs are not explicitly borne by the firms but
they arise due to the functioning of the firm. They do
not figure in the business decisions normally.
Such costs are borne by the society. They are not paid
for by the firm.
E.g. Mathura oil refinery discharging its wastage in
Yamuna river
Therefore social costs are those which refer to the
total costs borne by the society due to production of
a commodity .
Social costs includes the cost of resources for which
the firm is not supposed to pay i.e. atmosphere,
rivers, and also for use of public utility services like
roadways, drainage system etc.
6. Incremental costs and sunk costs
Incremental costs are closely linked to the concept of
Marginal cost . But while Marginal cost refers to the
cost of marginal unit of output,
Incremental costs refers to the total additional cost
associated with the decision to expand the output or
add a new variety of product etc. This concept is
useful because, it is based on the fact that in real
world, it is not practicable (for lack of perfect
divisibility of inputs) to employ factors for each unit
of output seperately

Sunk cost are those which are made once and for all
and cannot be altered, increased, or decreased, by
varying the rate of output, nor can they be
recovered.
the reason such costs are based on prior
commitment and cannot be revised or reversed or
recovered when there is a change in market
conditions or change in business decisions.
E.g. all the preceding costs which are already
undertaken are considered to be sunk costs.
Difference between Fixed and Sunk cost
Fixed Costs are costs that are paid by a firm
that is in business, regardless of the level of
output it produces.
E.g. Salaries of the key executives and
expenses for their office space and support
staff. Fixed costs can be avoided if the firm
goes out of business E.g. the key executives
will no longer be needed
Sunk costs are the costs that have been
incurred and cannot be recovered.
E.g. cost of a factory with specialised
equipment that is of no use in another
industry