INTRODUCTION TO THEORY OF COST

Cost is a bit elusive (not very easy) to define. Literally, a cost, from the point of view of a producer, is an expense incurred in the process of production of goods or rendering of services. From the point of view of a buyer, a cost is a price paid for goods or services received.

In Economics or business, cost is defined as: “The amount, measured in money, of cash expended (spent) in process of production or in consideration of goods or services received or tobe received”.

Briefly, cost is an expense.

Price definition

Price is a rate of exchange or exchange value of a commodity (or a service) measured in terms of money.

Production

We recall (repeat) that production is the act of making goods and rendering of services to satisfy human wants.

In this regard, production leads to incurring of cost. If there is no production, from the point of view of a firm, there would be no cost. As output (quantity of goods produced) rises, costs also increase, and vice versa. Therefore, production and cost have positive or direct relationship. Factually, our discussion of cost is more or less entirely based on firm’s costs.

Definition of Cost of Production

Cost of production may be defined as the sum total of all the payments to the factors of production used in the production of goods and services. For goods and services to be produced, all the four factors of production, which are land, capital, labour and entrepreneur, must work together. The various costs incurred in the use of these factors of production in order to produce goods and services are referred to as cost of production. Cost of production can also be related to all the rewards due to factors of production, which include rent for land, wages and salaries for labour, interest for capital and profit for entrepreneur.

Economist’s and Accountant’s view of cost.

Accountants regards cost as an expense. ‘It is the total amount of money expended (spent) in process of production of goods or rendering of services in a given period’. Briefly, it is money cost incurred in producing a commodity.

Economist views cost from the angle of alternative forgone. He regards it as opportunity cost (real cost) of any thing done, namely, how an individual can sacrifice one thing in order to obtain another. The money spent on a commodity is not what borders the economist but the alternative commodity that is left unbought in order to purchase that commodity.

In summary, an economist views cost in terms of opportunity cost, while an accountant views cost in terms of actual money spent.

Types of costs

For the systematic discussion of cost concept, costs are divided into four major groups: