Economics

Concept and Types of Cost

Nini Ezeugo - Thu, 09th May, 2019 @ 15:44: PM

Concept of Cost:

The term “cost” can be expressed in various forms. Generally, it will refer to money spent on a variety of stuffs. Below are some of the ways we may have spent money:

  • Money paid to rent.
  • Money paid for power and fuel.
  • Money paid to workers and labourers.
  • Investing our money and so on.

Recall that both the physical and financial input is necessary if we intend to enhance our productivity. Please read our article on production HERE. Based of this fact, it will be a good idea if entrepreneurs and those intending to start a business understand the concept of cost analysis; and this is what this article is about.

 

Cost can be put into the following types:

 

Accounting Cost 

When an entrepreneur pays cash (money) for the needed materials for production, such money is referred to as accounting cost. This money may be paid in the following ways

  • Money paid as rent.
  • Money paid for the purchase of raw materials.
  • Money paid for electricity.
  • Money paid to workers and so on.

Note: In Most cases, accounting costs are regarded as expenses and will be recorded in the credit side of an account. Read our article on the principle of double entry HERE.

 

Economic Cost

Consider this scenario. A man had a shop and intends to invest on the sale of phones; but he feared the risk involved in the business. As a result, he did not make the investment. The money that this man would had earn if he invested in the phone business is referred to as economic cost. Similarly, one person may decide to help the needy while another may choose to invest the money instead of helping the needy. If the latter made some profit in his investment and decides to help the needy with the profit, then that’s economic cost. Consider economic cost as a means of helping the entrepreneur to make supernormal (higher) profits, that is, the extra profit he would have made if an extra investment had been made.

 

Outlay Cost

Outlay costs are considered as expenditure in a business. The expenditure may come in the form of rent and wages. In a business, the outlay cost are generally treated as expenses.

 

Opportunity Cost

Think of opportunity cost as the income that would have been generate if the next best alternative had been taken. Let’s consider this instance: A man with N100 intends to buy a phone and laptop. If the N100 could only purchase one of these products (assuming he intends to maximize the products for the profit of his business). If this man went with the phone, then the profit he would have made if he had purchased the laptop is referred to as the opportunity cost. Please read our article on opportunity cost and scale of preference HERE

 

Fixed Cost

These are costs that don’t change regardless the volume of output. This cost will always remain constant even if there is a significant increase or decrease in output. Examples are rent and interest from loans.

 

Variable Cost

This cost is a function of output volume, that is, it will increase if output increases and decrease if output decreases. Examples of variable cost are cost of raw materials and payment of wages.

 

Direct Cost

A direct cost is a traceable cost since it can be directly linked or traced to its specific purpose. A direct cost will always be easily identifiable. One will need to know the purpose of a cost before concluding whether it’s direct or indirect. An example of direct cost may be the cost of acquisition of a specific material.

 

Indirect Cost

An indirect cost is not easily identifiable or traceable or linked to its specific purpose. For instance, this could be the cost of electricity if you don’t know how your electricity is measured.

 

Sunk Cost

As the name imply, they are forgone cost that cannot be recovered. An example is the money spent on advertising or research.

 

Incremental Cost

Incremental cost is incurred each time a change had been made. For instance, the cost made on software upgrade or machinery upgrade as a result of an increase in the number of customers.

 

Private Cost

Private cost results from the implementation of a personal objective. An instance is when an entrepreneur invests on his personal business which may come in the form of advertising or purchase of machineries.

 

Social Cost

The entrepreneur do not bear this cost, rather the society takes on the responsibility. This may include the cost to decrease environmental pollution within an area. The entrepreneur does not incur any expense on such projects eventhough he or she lives around this area.

Topics in Economics

Scale of Preference and Opportunity Cost Supply curve explained with graphical representation What is a Black Market, Its advantages and disadvantages Supply Curve and Elasticity of Supply Concept and Types of Cost



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