Page 125 - DECO405_MANAGERIAL_ECONOMICS
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Managerial Economics
Notes
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.
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.
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.
Notes 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 firm's resources which the firm forgoes in order to avail itself of the
returns from the best use of the resources. To take an 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".
Direct (or Separable or Traceable) Costs and Indirect (or Common or Non-traceable)
Costs
There are some costs which can be directly attributed to the production of a unit of a given
product. Such costs are direct costs and can easily be separated, ascertained and imputed to a unit
of output. This is because these costs vary with the output units. However, there are other costs
which cannot be separated and clearly attributed to individual units of production. These costs
are, therefore, classified as indirect costs in the accounting process.
Shut-down and Abandonment Costs
Shut-down costs are required to be incurred when the production operations are suspended and
will not be necessary if the production operations continue. When any plant is to be permanently
closed down, some costs are to be incurred for disposing off the fixed assets. These costs are
called abandonment costs.
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