Page 124 - DECO101_MICRO_ECONOMICS_ENGLISH

Unit 9: Cost Concepts

prices to get their services. These factors have alternative uses. The factors must be paid at least Notes
the price they are able to obtain in the alternative uses.

Example: Suppose a businessman can buy either a washing machine or a press machine
with his limited resources and suppose that he can earn annually ` 40,000 and ` 60,000 respectively
from the two alternatives. A rational businessman will certainly buy a press machine which gives
him a higher return. But, in the process of earning ` 60,000, he has forgone the opportunity to earn
` 40,000 annually from the washing machine. Thus, ` 40,000 is his opportunity cost or alternative
cost.
The difference between actual and opportunity costs is called economic rent or economic profi t.

Example: Economic profit from press machine in the above case is ` 60,000 – ` 40,000

= ` 20,000. So long as economic profit is above zero, it is rational to invest resources in press
machine.
9.1.6 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.
Example: Electricity charges may not be separable department-wise in a single product

firm or even product-wise in a multiple product firm. In a university, the salary of a vice-chancellor
is not traceable department-wise while that of a professor may be traceable department-wise.
Since all the direct costs are linked to a particular product/process/department, they vary with
changes in them. In other words, all direct costs are variable. On the other hand, indirect costs
may or may not be variable. Common costs may or may not change as a result of the proposed
changes in production level, production process or marketing process. So, indirect costs are both
variable and fi xed types.

9.1.7 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.

Example: If the production is suspended, the plant, machinery or equipment will have
to be protected by putting up sheds, using tarpaulin, plastic sheets, etc. Such costs are called
shut-down costs.
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.

9.1.8 Fixed and Variable Costs

There are some inputs or factors which can be adjusted with the changes in the output level.

Example: If a shirt manufacturer who produces 500 shirts per day wants to produce 1000
shirts per day now, can readily employ more labour and buy more raw materials. Thus, labour,
machinery, raw materials are the factors which can be readily varied with the change in output.
Such factors are called variable factors.

LOVELY PROFESSIONAL UNIVERSITY 119