The two major factors which decides & maximizes the
profit of a firm are
It is the level of cost relative to revenue that determines
the profit of the firm.
To increase the profit, firm tries to increase the revenue
and lowers the cost.
COST Refers to the Cost of Production
Total expenditure incurred in the production of a
It includes all the payments made to the factors of
4. COST CONCEPTS
1. Real Cost and Money Cost
2. Outlay Cost and Opportunity Cost
3. Past Cost and Future cost
4. Short Run Cost and Long Run Cost
5. Fixed and Variable Cost
6. Traceable and Common Cost
7. Out of Pocket Cost and Book Cost
8. Incremental Cost and Sunk Cost
9. Escapable Cost and Unavoidable Cost
10. Controllable Cost and Non-Controllable Cost
11. Historical Cost and Replacement Cost
12. Shut down Cost and Abandonment Cost
13. Urgent Cost and Postponable Cost
14. Private Cost and Social Cost
15. Accounting Cost and Economic Cost
5. Real Cost & Money Cost
Real Cost – The sacrifices made or then difficulties undergone by the producer during the course of
Money Cost – it consists of wages, interests, rent, cost of raw materials.
Money Cost of TWO types.
Explicit Cost – Payment made by producer to the owners of factors.
Implicit Cost – It arises in the case of those factors which are owned and supplied by the producer.
6. Outlay Cost & Opportunity Cost
Outlay Cost – refers to the actual costs incurred by a firm
for producing or acquiring a commodity.
Example – Cost of raw materials, wages of labourers, rent
for the land etc.
Opportunity Cost – it refers to the revenue foregone by
not making the best alternative use.
7. PAST COST & FUTURE COST
Past Cost – these are the actual costs incurred in the past
and recorded in the books of account.
Future Cost- cost which will take place in the future
period of time.
8. SHORT RUN COST AND LONG RUN COST
Short run Cost – cost incurred in the short period of time
i.e. within the maximum duration of one year.
Long run Cost – cost incurred in the long duration of time.
9. FIXED COST & VARIABLE
Fixed Cost – cost which remain constant with every
change in the output or production.
Variable Cost – those cost which varies (increase or
decrease) with every change in the output.
10. TRACEABLE COST &
Traceable Cost – these are directly related to a product, a
process or department of the firm.
Common Costs – those costs whose source cannot be
Example – Electricity charges.
11. OUT OF POCKET COST & BOOK
Out of Pocket Cost – those costs that involve immediate
payment to outsiders.
Example – payment of rent, wages, interest, transport
Book Cost – these do not involve current cash
12. INCREMENTAL COST &
Incremental Cost – additional costs incurred due to the
addition of a new product or change in the distribution
channels or addition of a new machine etc.
Sunk Cost – cost remain same even after a change in the
level or nature of business.
13. ESCAPABLE COST & UNAVOIDABLE
Escapable Cost – cost which can be avoided by the
producer during a production process.
Unavoidable Cost – those costs which cannot be avoided
by the producer at any point of time during the production
of a commodity.
Example- salary of the business manager.
14. CONTROLLABLE COST & NON-
Controllable Cost – those costs which can be controlled by
an executive with whose responsibility the cost is
Non-Controllable Cost – which are beyond the control.
15. HISTORICAL COST &
Historical Cost – cost of an asset. Example – plant and
Replacement Cost – refers to the price which would have
to be paid at present for acquiring the same asset.
16. SHUT DOWN COST &
Shut down Cost – cost incurred by a firm if it temporarily
stops its operation.
Abandonment Cost – these are the costs of retiring
altogether a fixed asset from use.
It creates a problem of disposal of fixed assets.
17. URGENT COST &
Urgent Cost – those costs which must be incurred in order
to continue the operations of the firm.
Example – Cost of labour and raw material.
Postponable Cost – those costs which can be avoided at
present or which can be postponed.
Example –maintenance of buildings.
18. PRIVATE COST & SOCIAL COSTS
Private Cost – it is the actual cost of producing a
commodity incurred by a individual firm.
Social Cost – incurred by the society in the form of
resources that are used in order to produce the goods.
19. ACCOUNTING AND ECONOMIC COST
Accounting Cost – those costs which are recorded in the
books of accounts by the accountants.
Economic Costs – it includes both implicit cost and
explicit cost or in other words both the costs which are
recorded and not recorded are called as the economic
20. DETERMINANTS OF COSTS
The determinants of cost are as follows.
1. Size of plant
2. Level of output
3. Prices of inputs
4. Productivities of factors of production
6. Managerial efficiency
21. COST FUNCTION
It explains the relationship between cost and its determinants in a
S= Size of plant
O=Level of Output
P=Price of Inputs
22. Size of Plant – there is an inverse relationship between size of plant (the Scale of
Operations) and the unit cost. As the size of plant increases unit cost declines and
Level of Output – total cost varies directly with the output.
Prices of Inputs – the changes in the prices of inputs directly affects the cost of
Productivities of Factors of Production – Productivities of factors of production
inversely affect cost of production.
Technology- improve in the technology leads to the improvement in the efficiency
of the factors of production and it reduces the cost of production.
Managerial Efficiency – it is difficult to quantify the influence of managerial
efficiency upon cost. Its effect on cost can be explained by taking the costs at two
points of time.
23. COST – OUTPUT RELATIONSHIP
Cost-output relationship is one of the important concept in
Cost function usually refers to the relationship between
cost and the rate of output, keeping all other variables
Cost output relationship can be discussed under short run
and long run separately.
24. COST- OUTPUT RELATIONSHIP IN THE SHORT RUN
The short run is a period of time in which output can be
increased or decreased by changing only the amount of
variable factors such as labour, raw materials etc.
The cost-output relationship in the short run may be
studied in terms of
i. Total cost
ii. Unit cost or average cost Short Run Cost-
Average Cost –