Page 122 - DECO101_MICRO_ECONOMICS_ENGLISH

Unit 9: Cost Concepts

Introduction Notes

Cost is one of the most important considerations for suppliers or producers.

Example: For producing a motorcycle, producer needs spare parts, labour, transport
etc... All of them have their own price which is the cost for the producer.

Costs play a very important role in decisions involving a selection between alternative courses
of action.
Costs enter into almost every economic decision and it is important to use the right analysis of
cost. Even in your routine decisions, analysis of cost is involved.

Example: You might choose to buy clothes from Shop A because the clothes there are
cheaper than anywhere else and since, it is near your house, you save your time and energy too.
So, you save on monetary as well as time and energy costs.
Hence, it is important to understand what these various concepts of costs are, how these can be
defined and used.

9.1 Types of Costs

Cost is something of value, usually an amount of money, given up in exchange for something
else, usually goods or services. In other words, Cost is the value that must be given up to acquire
or produce a good or service. All expenses are costs, but not all costs are expenses. (An expense
is the cost of resources used to produce revenue.) As a verb, cost means to estimate the amount
of money needed to produce a product or perform a service.
There are many different types of costs, as discussed in following subsection.

9.1.1 Future and Past Costs

Future is uncertain and it is an important consideration of all business decisions. Future costs are
the estimates of time adjusted past or present costs and are reasonably expected to be incurred
in some future period or periods. Their actual incurrence is a forecast and their management
is an estimate. They are the only costs that matter for managerial decisions because they are
subject only to management control. The major managerial uses where future costs are relevant
are: cost control, projection of future profit and loss statements, appraisal of capital expenditure,

introduction of new products, expansion programmes and pricing.
Past costs are actual costs incurred in the past and they are always contained in the income
statements. Their measurement is essentially a record keeping activity. These costs can only be
observed and evaluated in retrospect. Past costs are, therefore, those unadjusted historical cost
data which have been recorded in the books.

9.1.2 Incremental and Sunk Costs

Incremental costs are defined as the change in overall costs that result from particular decisions

being made. Incremental costs may include both fixed and variable costs. In the short period,
incremental cost will consist of variable cost – costs of additional labour, additional raw materials,
power, fuel, etc. – which is the result of a new decision being taken by the firm. Since these costs

can be avoided by not bringing about any change in the activity, incremental costs are also called
avoidable costs or escapable costs. Moreover, since incremental costs may also be regarded as the
difference in total costs resulting from a contemplated change, they are also called differential
costs.

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