COST ANALYSIS

Mr. Nithin Kumar SAssistant ProfessorDepartment of EconomicsSt. Aloysius College (Autonomous)Mangaluru- 575003

INTRODUCTIONThe two major factors which decides & maximizes the

profit of a firm are1. Cost2. Revenue It is the level of cost relative to revenue that determines

the profit of the firm. To increase the profit, firm tries to increase the revenue

and lowers the cost.

MEANING COST Refers to the Cost of ProductionTotal expenditure incurred in the production of a

commodity.It includes all the payments made to the factors of

production.

COST CONCEPTS1. Real Cost and Money Cost

2. Outlay Cost and Opportunity Cost

3. Past Cost and Future cost

4. Short Run Cost and Long Run Cost

5. Fixed and Variable Cost

6. Traceable and Common Cost

7. Out of Pocket Cost and Book Cost

8. Incremental Cost and Sunk Cost

9. Escapable Cost and Unavoidable Cost

10. Controllable Cost and Non-Controllable Cost

11. Historical Cost and Replacement Cost

12. Shut down Cost and Abandonment Cost

13. Urgent Cost and Postponable Cost

14. Private Cost and Social Cost

15. Accounting Cost and Economic Cost

Real Cost & Money Cost Real Cost – The sacrifices made or then difficulties undergone by the producer during the course of

production.

Money Cost – it consists of wages, interests, rent, cost of raw materials.

Money Cost of TWO types.

Explicit Cost – Payment made by producer to the owners of factors.

Implicit Cost – It arises in the case of those factors which are owned and supplied by the producer.

Money Cost

Explicit Cost Implicit Cost

Outlay Cost & Opportunity Cost

Outlay Cost – refers to the actual costs incurred by a firm

for producing or acquiring a commodity.

Example – Cost of raw materials, wages of labourers, rent

for the land etc.

Opportunity Cost – it refers to the revenue foregone by

not making the best alternative use.

PAST COST & FUTURE COSTPast Cost – these are the actual costs incurred in the past

and recorded in the books of account.

Future Cost- cost which will take place in the future

period of time.

SHORT RUN COST AND LONG RUN COST

Short run Cost – cost incurred in the short period of time

i.e. within the maximum duration of one year.

Long run Cost – cost incurred in the long duration of

time.

FIXED COST & VARIABLE COSTFixed Cost – cost which remain constant with every

change in the output or production.

Variable Cost – those cost which varies (increase or

decrease) with every change in the output.

TRACEABLE COST & COMMON COST

Traceable Cost – these are directly related to a product, a

process or department of the firm.

Common Costs – those costs whose source cannot be

traced.

Example – Electricity charges.

OUT OF POCKET COST & BOOK COST Out of Pocket Cost – those costs that involve immediate

payment to outsiders.

Example – payment of rent, wages, interest, transport

charges etc.

Book Cost – these do not involve current cash

expenditure.

INCREMENTAL COST & SUNK COSTIncremental Cost – additional costs incurred due to the

addition of a new product or change in the distribution

channels or addition of a new machine etc.

Sunk Cost – cost remain same even after a change in the

level or nature of business.

ESCAPABLE COST & UNAVOIDABLE COSTEscapable Cost – cost which can be avoided by the

producer during a production process.

Unavoidable Cost – those costs which cannot be avoided

by the producer at any point of time during the production

of a commodity.

Example- salary of the business manager.

CONTROLLABLE COST & NON-CONTROLLABLE COST

Controllable Cost – those costs which can be controlled

by an executive with whose responsibility the cost is

identified.

Non-Controllable Cost – which are beyond the control.

HISTORICAL COST & REPLACEMENT COSTHistorical Cost – cost of an asset. Example – plant and

machinery.

Replacement Cost – refers to the price which would have

to be paid at present for acquiring the same asset.

SHUT DOWN COST & ABANDONMENT COSTShut down Cost – cost incurred by a firm if it temporarily

stops its operation.

Abandonment Cost – these are the costs of retiring

altogether a fixed asset from use.

It creates a problem of disposal of fixed assets.

URGENT COST & POSTPONABLE COSTUrgent Cost – those costs which must be incurred in order

to continue the operations of the firm.Example – Cost of labour and raw material.Postponable Cost – those costs which can be avoided at

present or which can be postponed.Example –maintenance of buildings.

PRIVATE COST & SOCIAL COSTSPrivate Cost – it is the actual cost of producing a

commodity incurred by a individual firm.

Social Cost – incurred by the society in the form of

resources that are used in order to produce the goods.

ACCOUNTING AND ECONOMIC COST

Accounting Cost – those costs which are recorded in the books of accounts by the accountants.

Economic Costs – it includes both implicit cost and explicit cost or in other words both the costs which are recorded and not recorded are called as the economic costs.

DETERMINANTS OF COSTSThe determinants of cost are as follows.1. Size of plant2. Level of output3. Prices of inputs4. Productivities of factors of production5. Technology6. Managerial efficiency

COST FUNCTION It explains the relationship between cost and its determinants in a

mathematical form

C=f(S,O,P,T.....)

C=Cost

S= Size of plant

O=Level of Output

P=Price of Inputs

T=Technology

&So On...

Size of Plant – there is an inverse relationship between size of plant (the Scale of

Operations) and the unit cost. As the size of plant increases unit cost declines and vice

versa.

Level of Output – total cost varies directly with the output.

Prices of Inputs – the changes in the prices of inputs directly affects the cost of

production.

Productivities of Factors of Production – Productivities of factors of production

inversely affect cost of production.

Technology- improve in the technology leads to the improvement in the efficiency of the

factors of production and it reduces the cost of production.

Managerial Efficiency – it is difficult to quantify the influence of managerial efficiency

upon cost. Its effect on cost can be explained by taking the costs at two points of time.

COST – OUTPUT RELATIONSHIPCost-output relationship is one of the important concept in

managerial economics.Cost function usually refers to the relationship between

cost and the rate of output, keeping all other variables constant.

Cost output relationship can be discussed under short run and long run separately.

COST- OUTPUT RELATIONSHIP IN THE SHORT RUN

The short run is a period of time in which output can be increased or decreased by changing only the amount of variable factors such as labour, raw materials etc.

The cost-output relationship in the short run may be studied in terms of

i. Total costii. Unit cost or average cost

Short Run Cost-Output Relationship

Total Cost-Output Relationship

Average Cost – Output Relationship