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Micro Economics

Notes Sunk cost is one which is not affected or altered by a change in the level or nature of business
activity. It will remain the same whatever the level of activity. The most important example of sunk
cost is the amortisation of past expenses, e.g., depreciation. Sunk costs are irrelevant for decision
making as they do not vary with the changes considered for future by the management.
9.1.3 Replacement and Historical Costs

Historical cost of an asset states the cost of plant, equipment and materials at the price paid
originally for them, while the replacement cost states the cost that the firm would have to incur if

it wants to replace or acquire the same asset now.

Example: If the price of bronze at the time of purchase, say, in 1974, was ` 15 a kg and if
the present price is ` 18 a kg, the original cost of ` 15 is the historical cost while ` 18 is replacement
cost. Replacement cost means the price that would have to be paid currently for acquiring the
same plant.

9.1.4 Explicit Costs and Implicit or Imputed Costs (Accounting Concept of
Cost and Economic Concept of Cost)

Explicit costs are those expenses which are actually paid by the firm (paid-out-costs). These costs
appear in the accounting records of the firm. On the other hand, implicit costs are theoretical

costs in the sense that they go unrecognised by the accounting system. These costs may be

defined as the earnings of those employed resources which belong to the owner himself. The
examples of such costs are opportunity cost of the owner’s services, say, as the manager of the

firm, opportunity cost of land belonging to the owner of the firm and normal return equal to the

market rate of interest on the owner’s own capital invested in the business. These implicit costs

are not included by the accountant of the firm in its accounting statements. However, these costs

are considered relevant by economists while calculating the economic profits of the fi rm.
9.1.5 Actual Costs and Opportunity Costs
Actual costs mean the actual expenditure incurred for acquiring or producing a good or service.
These costs are the costs that are generally recorded in books of account, for example, actual
wages paid, cost of materials purchased, interest paid, etc. These costs are also commonly called
absolute costs or outlay costs.
The concept of opportunity cost occupies a very important place in modern economic analysis.
The opportunity costs or alternative costs are the returns from the second best use of the fi rm’s

resources which the firm forgoes in order to avail itself of the returns from the best use of the
resources.

Example: A farmer who is producing wheat can also produce potatoes with the same
factors. Therefore, the opportunity cost of a quintal of wheat is the amount of the output of
potatoes given up.

Thus, we find that the opportunity cost of anything is the next best alternative that could be
produced instead by the same factors or by an equivalent group of factors, costing the same

amount of money. Two points must be noted in this definition. Firstly, the opportunity cost of
anything is only the next best alternative foregone. Secondly, in the above definition it is the

addition of the qualification “or by an equivalent group of factors costing the same amount of

money”.
The alternative or opportunity cost of a good can be given a money value. In order to produce
a good the producer has to employ various factors of production and has to pay them suffi cient

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