Question

What do you understand by Cost of Production in Economics?

Answer 1

COST OF PRODUCTION -

 

Ordinarily, the term cost is taken to mean the money paid to produce or provide a good. In this way, it is the monetary expenditure incurred for the production of a commodity. But here we must keep in mind the fact, that the cost is not confined to the payment of expenses made but it would include other indirect expenses related to that production process. For example, a producer spends $2000 on raw material, labour and power. In addition to this, he also uses a portion of his house for production activity, which could fetch him $500 per month, if let out. This amount is also his cost which we shall call an indirect or implicit cost. In this way, the total cost of production is $2500, which includes both explicit cost of $2000 and the implicit cost of $500. Hence, we can define the production cost as follows.

 

"By cost of production we mean the value of inputs used in the process of production."

 

The total cost of production has got two components which are called Fixed Cost and Variable Cost. Hence,

                   

Total Cost  =  Fixed Cost  +  Variable Cost                                                      or                                               TC = FC + VC

       

Fixed Cost is that cost, which is incurred on fixed factors of production or those factors which do not change by every change in output, like cost of land, building, machine, fixtures, management etc. Accordingly, the Fixed Cost is that cost which does not change with every change in output. For example, rent of land or building, interest on borrowed capital, wages of the watchman, salaries of managerial staff, electricity charges for lighting, maintenance etc. are all fixed costs.

Variable Cost, on the other hand, is that cost which changes as per level of output. In other words, when we increase output, variable cost will increase, and when we decrease output, variable cost will decrease. If we bring our production to zero level, the variable cost will also become zero, although fixed cost will continue to he incurred in the same amount. Therefore, expenditure on raw material, direct labour, power and fuel, transport etc. are the variable costs.

If we divide the total Fixed Cost and Variable Cost by the total output we get Average Cost or cost per unit.

 

Average Total Cost  =  Average Fixed Cost  +  Average Variable Cost                                                           or                                            ATC = AFC + AVC

         

ATC is often written as AC or Average Cost. If we try to find Marginal Cost, we find that marginal cost of fixed cost is zero. Hence,

 

MC = MVC

"By cost of production we mean the value of inputs used in the process of production."