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Unit 9: Cost Concepts

within the industry have equal access to them. The external economies do not, therefore, distort Notes

competitive elements. In contrast, the internal economies may drive a firm to enjoy monopoly
power.
As internal economies may get transformed into internal diseconomies, the external economies
may also get converted into external diseconomies. This happens when the industry expands

in size indefinitely and the control of industry becomes a problem. Environmental pollution is
a good example of external diseconomies as a result of which private as well as social costs of
production may increase. In modern times when in most of the countries, industrial development
is a planned activity, the responsibility of creating external diseconomies may be largely fi xed
on the government, particularly its planning unit. The objective of planned industrialisation is to
maximise the net externalities (= external economies – external diseconomies).

9.5 Summary

Costs enter into almost every business decision and it is important to use the right analysis
of cost. Different business problems call for different kinds of costs such as future and past
costs, incremental and sunk cost, out of pocket and book costs, replacement and historical
cost etc.

Fixed costs are those costs which do not very with the change in the level of output in the
short run. Variable costs change with output levels.
The short run is a period of time in which the output can be increased or decreased by
changing only the amount of variable factors such as labour, raw materials, chemicals, etc.
Long run, on the other hand, is defined as the period of time in which the quantities of all

factors may be varied.

There are short run average fixed cost and variable cost as well as long run average costs.
Total cost is the sum of total of the explicit plus implicit expenditure. Average cost is the
cost per unit of output. Marginal cost is the extra cost of producing one additional unit.

In order to maximise TR, the first order condition is that the MR should be zero and the
second order condition is that slope of MR curve should be negative.
9.6 Keywords

Actual costs: Actual expenditure incurred for acquiring or producing a good or service.

Direct costs: Costs which can be directly attributed to the production of a unit of a given
product.
Explicit costs: Expenses which are actually paid by the fi rm (paid-out-costs).

Fixed factors: Factors such as capital equipment, building, top management personnel which
cannot be readily varied with the change in output.
Implicit costs: Theoretical costs which go unrecognized by the accounting system.
Indirect costs: Costs which cannot be separated and clearly attributed to individual units of
production.
Opportunity costs: The return from the second best use of the firm’s resources which the fi rm

forgoes in order to avail itself of the return from the best use of the resources.
Variable costs: Costs which are incurred on the employment of variable factors of production
whose amount can be altered in the short-run.
Variable factors: Factors such as labour, raw materials, chemicals which can be readily varied
with the change in output.

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