Question

1. What different ways could we look at costs and conceptualize costs as they relate to a firm?
2. Why do costs matter to your firm? How can we employ an understanding of costs to optimally manage our firm?
3. You are the manager of a firm producing computers. How do you decide how many computers to produce for sale? Use a fully labeled economic model and a brief explanation to justify your thinking.
4. Two scenarios. First, you purchased a ticket to go to a concert for $20. When you arrive at the venue, you realize you lost your ticket. Would you purchase another one? Second, you are going to a concert that costs $20 and didn’t purchase a ticket. When you arrive at the venue, you realize you lost $20. Would you still purchase the ticket? Discuss and explain

Answer 1

1. Accounting and Economic Costs

The total money expenses incurred by a firm in producing a commodity are called money cost. Expenditure on fixed asset, wages and salaries, depreciation, cost of raw material, rent, interest on capital borrowed, expenses on power, light , fuel and all type of taxes. These are explicit costs.

Economic costs called implicit costs are spent on owners own resources and services.

2. Production Costs

Total costs of a firm are divided into two parts - total variable costs and total fixed costs.

Total variable costs are those which changes with change in firms output.

Total fixed costs are those which do not change with the change in output.

3. Actual Costs and Opportunity Costs:

​​​​​​Actual costs are those which a firm acquires for producing goods and services.

Opportunity cost is the sacrifice cost of the best alternative.

Importance of Opportunity Cost:

The concept of opportunity cost is very important in the following areas of managerial decision making:

(i) Decision-Making and Efficient Resource Allocation:

The concept of opportunity cost is very important for rational decision-making by the producers.

As a result, efficient allocation of resources will also be possible. A resource will always be used in that business where it will have the highest opportunity cost.

(ii) Determination of Relative Prices of Goods:

The concept of opportunity cost is useful in the determination of relative prices of various goods.

(iii) Determination of Normal Remuneration of a Factor:

Opportunity cost determines the price for the best alternative use of a factor of production.

4. Direct Costs and Indirect Costs:

Direct costs are the costs that have direct relationship with a unit of operation, i.e., they can be easily and directly identified.

On the other hand, indirect costs are those costs whose source cannot be easily and definitely traced.

All the direct costs are variable because they are linked to a particular product or department. Therefore, they vary with changes in them.

5. Private and Social Costs:

Private costs are the costs incurred by a firm in producing a commodity or service. These include both explicit and implicit costs.

On the other hand, production of such services as education, sanitation services, park facilities, etc. leads to social benefits. These are social costs.

6. Incremental Costs and Sunk Costs:

Incremental costs denote the total additional costs associated with the marginal batch of output. These costs are the additions to costs resulting from a change in the nature and level of business activity.

Sunk costs are the costs that are not affected or altered by a change in the level or nature of business activity. It cannot be altered, increased or decreased by varying the level of activity or the rate of output.

7. Historical and Replacement Costs:The historical cost is the actual cost of an asset incurred at the time the asset was acquired.

The concept of replacement cost is very useful for the management. It projects a true picture while the historical cost gives poor projection to the management.

8. Past Costs and Future Costs:

Past costs are the costs which have been actually incurred in the past. They are beyond the control of the management because they are already incurred. Guture costs refer to the costs that are reasonably expected to be incurred in some future periods.

9. Business Costs and Full Costs:

Business costs are the costs which include all the payments and contractual obligations made by the firm together with the book cost of depreciation on plant and equipment.

Full costs consist of opportunity costs and normal profit. Opportunity costs are the expected earnings from the next best use of the firm’s resources. Normal profit is the minimum profit required for the existence of a firm.

10. Common Production Costs and Joint Costs:

Common costs are the costs which cannot be traced to separate products in any direct manner.

When an increase in the production of one product results in an increase in the output of another product, such products are joint products and their costs are joint costs.

11. Shutdown Costs and Abandonment Costs:

Shutdown costs are the costs that are incurred in the case of a closure of plant operations. If the operations are continued, these costs can be saved.

Abandonment costs are the costs which are incurred because of retiring altogether a plant from use. These costs are related to the problem of disposal of assets.

12. Out-of-Pocket Costs and Book Costs:

The costs which include cash payments or cash transfers that may be recurring or non-recurring are called out-of-pocket costs.

Book costs are the actual business costs which enter into book accounts but are not paid in cash. They are considered while finalising the profit and loss accounts.

13. Urgent Costs and Postponable Costs:

Urgent costs are those costs that are necessary for the continuation of the firm’s activities. The cost of raw materials, labour, fuel, etc.

The costs which can be postponed for some time, i.e., whose postponement does not affect the operational efficiency of the firm are called postponable costs.

14. Escapable Costs and Unavoidable Costs:

Escapable costs are the costs which can be reduced by contraction in business activities. Here, net effect on costs is important.

On the other hand, unavoidable costs are the costs which do not vary with changes in the level of production, but they are unavoidable such as fixed costs.

15. Incremental Costs and Marginal Costs:

Incremental cost is used in a broad sense in relation to marginal cost.

Marginal cost is the cost of producing an additional unit of output