THEORY OF COST.pptx

theory of cost

1. THEORY OF COST Submitted by: Bhawna

2. Cost The concept of cost is a key concept in Economics. It refers to the amount of payment made to acquire any goods and services. In a simpler way, the concept of cost is a financial valuation of resources, materials, risks, time and utilities consumed to purchase goods and services.

3. TYPES OF COST Accounting Costs / Explicit Costs The cost of production including employee salaries, raw material cost, fuel costs, rent expenses and all the payments made to the suppliers from the accounting costs. Economic Costs / Implicit Costs According to the modern theory of cost in economics, the investment return amount of a businessman, the amount that could have been earned but not paid to an entrepreneur and monetary rewards for all estates owned by the businessman form the economic costs.

4. TYPES OF COST Outlay Costs These are the recorded account costs or actual expenditure spent on wages, rent, raw materials and more. Opportunity Costs These are the missed opportunity costs. They are not recorded in the account books but show the cost of sacrificed or rejected policies. Direct / Traceable Costs These costs are easily pointed out or identified expenditures such as manufacturing costs. Such costs cater to specific operations or goods.

5. TYPES OF COST Indirect / Non-Traceable Costs These costs are not related directly or identifiable to any operation or service. Costs such as electric power or water supply are some examples because these expenses vary with output. They generally have a functional relationship with production. Fixed Costs Such costs do not vary with output and are fixed expenditure of the company. For example, taxes, rent, interests are all fixed costs as they do not vary within a constant capacity. Any company cannot avoid these costs. Variable Costs These costs vary with output and are known as a variable cost. For example, salaries of the employee, raw material costs all fall under variable costs. These directly depend on the fixed amount of resources.

6. COST FUNCTION The cost function measures the minimum cost of producing a given level of output for some fixed factor prices. The cost function describes the economic possibilities of a firm. Cost functions are important in studying the determination of optimal output choices. The general form of the cost function formula is C(x)=F+V(x) C ( x ) = F + V ( x ) where F is the total fixed costs, V is the variable cost, x is the number of units, and C(x) is the total production cost.

7. COST OUTPUT RELATIONSHIP The cost-output relationship plays an important role in determining the optimum level of production. Knowledge of the cost-output relation helps the manager in cost control, profit prediction, pricing, promotion etc. The relation between cost and its determinants is technically described as the cost function. C= f (S, O, P, T ….) Where; C= Cost (Unit or total cost) S= Size of plant/scale of production O= Output level P= Prices of inputs T= Technology

8. TOTAL COSTS For any business, Total Costs (TC) = Total Fixed Cost (TFC) + Total Variable Cost (TVC). Total fixed cost (TFC) is constant regardless of how many units of output are being produced. Fixed cost reflect fixed inputs. Total variable cost (TVC) reflects diminishing marginal productivity -- as more variable input is used, output and variable cost will increase. As the additional variable input leads to a smaller increase in production (diminishing marginal productivity), a business must spend more on variable inputs to produce one more unit of output.

9. MARGINAL COST M arginal cost is the change in total production cost that comes from making or producing one additional unit. To calculate marginal cost, divide the change in production costs by the change in quantity. The purpose of analyzing marginal cost is to determine at what point an organization can achieve economies of scale to optimize production and overall operations. If the marginal cost of producing one additional unit is lower than the per-unit price, the producer has the potential to gain a profit.

10. SHORT RUN AVERAGE COST If the estimate is done for a short period that does not consider the change in the number of goods, it is called short-run average cost. We can derive it by dividing the entire cost by the total number of goods that we want to produce.

11. LONG RUN AVERAGE COST Long-run average total cost (LRATC) is a business metric that represents the average cost per unit of output over the long run, where all inputs are considered to be variable and the scale of production is changeable.

12. REFERENCES https://www.slideshare.net/ShompaDhali/theory-of-cost-117440614 https://www.vedantu.com/commerce/theory-of-cost https://www.mbaknol.com/managerial-economics/cost-output-relationship/ https://www.ag.ndsu.edu/aglawandmanagement/agmgmt/coursematerials/productiontheory/determiningcost

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