The following points highlight the top five concepts of cost. The concepts are: 1. Accounting Cost 2. Opportunity Cost 3. Imputed Cost or Implicit Cost 4. Sunk Cost 5. Private and Social Costs.
Concept of Cost # 1. Accounting Cost:
The concept of accounting cost is used by accountants. Money expenses incurred for hiring different input services are calculated. These are then accounting costs, or explicit costs, or direct costs. These are in the nature of purchase of raw materials, equipment, wages, rent, interest, etc.
Since actual payment has to be made to others by the firm, these costs are also called explicit costs. As these costs get reflected in accounting statements, these are called accounting costs and accountants take a ‘retrospective look’ of the firm’s finances.
Concept of Cost # 2. Opportunity Cost:
Cost is an important element in decision-making. That is why economists evaluate cost in terms of the concept of opportunity cost or forgone alternatives.
ADVERTISEMENTS:
Every action involves an opportunity cost. When an individual works in an office, he sacrifices other alternative job opportunities. Suppose, a worker of a merchant office gives up a job fetching a salary of Rs. 5,000 per month and instead becomes a self-employed person. Thus the accounting cost of this worker is zero while opportunity cost is Rs. 5,000 per month—the earning he sacrifices by working for his own business.
This is the opportunity cost. “The cost of using something in a particular use is the benefit forgone by (or opportunity cost) not using in its best alternative use.” Thus the opportunity cost is the ‘forward-looking’ view of the firm over a range of choices. The opportunity cost of any decision is the value that the next best alternative would give.
The opportunity cost may be greater or less than the accounting cost.
Concept of Cost # 3. Imputed Cost or Implicit Cost:
Imputed cost is the cost attributed for using a factor of production which is owned by the user. Imputed cost is the opportunity cost of not using an input or machine to its best alternative use.
ADVERTISEMENTS:
In other words, imputed cost (or implicit cost) represents the value of forgone opportunities but do not involve actual cash payments. Economists just impute or estimate a price for these owned resources equal to the return they would have received in their best use. This is called imputed cost or implicit cost not included in accounting cost.
Thus, economic costs include both accounting costs and imputed costs to evaluate costs of production. To discover the profitable line of production economists evaluate costs both explicitly and implicitly. Economists count costs as
Economic cost = Explicit costs + Implicit costs
While calculating economic costs, economists take a ‘forward-looking’ view.
Concept of Cost # 4. Sunk Cost:
ADVERTISEMENTS:
A sunk cost is an expenditure of a firm incurred in the past which is not recoverable. Since it cannot be recovered, it cannot influence production decision. In this sense, any fixed cost incurred in production is a sunk cost.
Expenditure on specialized equipment of a firm much before production starts is a sunk cost since it has no alternative use. Its opportunity cost is, thus, zero. As sunk cost is not relevant to economic decisions even if it is seen as a mistake, one should follow Jevons’ famous economic maxim – “Bygones are forever bygones.”
Concept of Cost # 5. Private and Social Costs:
Being a profit maximiser, a firm simply estimates or calculates private costs of production that include both accounting cost and imputed cost or opportunity cost. These private costs do not include costs that are imposed on the society.
A factory in the adjoining locality pollutes the environment, and creates traffic congestion— causing accidents and deaths. These are the costs that are borne by the society. Social cost is the sum of private costs plus any additional cost imposed on the society from any economic activity.